Mortgage-Backed Security (“MBS”) is a type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by an accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from a regulated and authorized financial institution.
When you invest in a MBS you are essentially lending money to a home buyer or business. An MBS is a way for a smaller regional bank to lend mortgages to its customers without having to worry about whether the customers have the assets to cover the loan. Instead, the bank acts as a middleman between the home buyer and the investment markets.
This type of security is also commonly used to redirect the interest and principal payments from the pool of mortgages to shareholders. These payments can be further broken down into different classes of securities, depending on the riskiness of different mortgages as they are classified under the MBS.
ABS, also known as Asset-Backed Security, is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually. Pooling the assets into financial instruments allows them to be sold to general investors, a process called securitization and allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the diverse pool of underlying assets. For investors, asset-backed securities are an alternative to investing in corporate debt.
ABS are similar to Mortgage-Backed Security, except that the securities backing it are assets such as loans, leases, credit card debt, a company’s receivables, royalties and so on, and not mortgage-based securities.