A mortgage-backed security is a financial instrument that is derived from property mortgages. Essentially, the creation of a mortgage backed security involves the bundling and selling of multiple real estate mortgages. This article will explain the concept of mortgage backed securities, how mortgages become these financial instruments and what happens to the ownership of mortgage loans after they become mortgage backed securities. Section one will illustrate the meaning of mortgage-backed securities, section two will outline the process of mortgage securitization and section three will address the question of mortgage ownership.
What mortgage-backed securities are
Mortgage backed securities are derivatives meaning their value is premised on 1) the quality of the underlying mortgage 2) the price of the real estate the underlying mortgage(s) are for and 3) the up to date payment of the mortgages. Mortgage backed securities are insured by mortgage default swaps, which allow the buyer of mortgage backed securities to receive indemnification in the case of the failure of the underlying mortgages to stay current. Consequently, the credit rating of the mortgage-backed security is important to its insurability and valuation.
Several types of mortgage baked securities exist including "CMO's, REMIC's, PO's, and IO's" (teachmefinance.com) These acronyms refer to the specific nature of each type of mortgage backed security. For example, a Collateralized mortgage obligation (CMO) is different from Real estate mortgage investment conduit (REMIC). In the case of a CMO, mortgages become valued via a group of bonds that's interest, value and longevity are determined by the risk and valuation of the underlying mortgages. A REMIC however, is more like an ownership trust, than a collateralized financial instrument. However, a REMIC has the capacity to collateralize mortgages with financial instruments such as bonds and other forms of ownership.
How mortgages become mortgage backed securities
The process of how mortgages become derivatives or "mortgage backed securities" is quite simple in principle. What isn't as simple is the identification of underlying ownership after a mortgage has been securitized. In other words, the chain of events, legal paper trail and number of steps involved in the creation of mortgaged backed securities can become so elaborate and bureaucratic, that the practicality of tracing both ownership and value becomes overly complicated.
To illustrate, the mortgage application and origination procedure can involve quite a lot of paperwork as many home buyers are aware of. Following this, mortgage companies package and resell groups of mortgages to banks who pay an immediate return on the value of the mortgages for a discount on the present value of future cash flow i.e. value of interest amortization. The banks who buy these mortgages then re-distribute them so they can make a profit off them, these re-distributions are the mortgage backed securities and are classified by the credit rating of the underlying mortgages. These derivatives are then classified and valued by third parties and sold to investors and/or investment organizations. Thus the actual ownership of a mortgage changes several hands and goes through much re-organization and re-distribution after the origination.
The ownership of mortgages after securitization
Since mortgages that are securitized are bundled, packaged, bought, sold, leveraged, collateralized etc., the actual ownership of a mortgage loan as opposed to the mortgage property that is held by the home-buyer, can be obscure. The reason it can become obscure is that after the mortgage is repackaged it transforms into a re-categorized financial instrument rather than a individually traceable group of mortgages. Since the underlying mortgages are classified by repayment risk, the actual ownership become less relevant than the class of the bonds or mortgage derivative, mortgage derivative holder etc.
Since a legal and financial trail of ownership must exist for mortgage backed securities, ownership is traceable, it's just not convenient to actualize an ownership trace on a daily basis when the digital money flow is all that is needed by investors and financial institutions involved. That is to say, so long as mortgages and/or groups of mortgages in the form of mortgage backed securities can be assessed in terms of percentage defaults, foreclosures etc., the actual ownership become monetized rather than personalized in the securitization process i.e. to the home owners, the ownership of title is important, and to the banks, other financial corporations and investors, the value of the mortgage loans is what's important. Such being the case, aggregate numbers become more important than aggregate names making tracing ownership of mortgages difficult after securitization.
Summary
To summarize, mortgage loan rather than title ownership can be difficult to locate after securitization because of the process involved in the transformation of mortgages to mortgage backed securities. Essentially, this process involves a sequence of events in which mortgages become valued, assessed, categorized and packaged and then valued thereafter in terms of aggregate numbers and percentages rather than on a case by case basis in which the mortgage borrowers name is of relevance.
In simpler terms, the value of the mortgage derivatives becomes of higher importance and thus greater priority is placed on the valuation of the derivatives than the defining of ownership. When mortgage backed securities are resold to investors, the investors are simply less concerned with who actually borrowed the mortgage than the quality and repayment of the mortgage and its representative value. Thus, in the process of mortgage securitization, ownership of the resold mortgage, and defining of that ownership becomes less important than the valuation thus the numerical information flow representing value is given more importance and accessibility than the ownership trail.
Sources:
1. http://www.allbusiness.com/personal-finance/real-estate-mortgage-loans/953732-1.html
2. http://www.teachmefinance.com/Financial_Terms/mortgage_derivative.html
3. http://www.sec.gov/answers/tcmos.htm
4. http://financial-dictionary.thefreedictionary.com/Real+Estate+Mortgage+Investment+Conduit
5. http://images.google.com/imgres?imgurl=http://1.bp.blogspot.com/_
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