# What Are Mortgage Bonds? Definition, Benefits, and Risks Explained

## What Is a Mortgage Bond?

A mortgage bond, secured by real estate assets, provides investors with protection due to its underlying value. In case of default, this asset can be liquidated to compensate bondholders. While safer, mortgage bonds typically yield lower returns compared to corporate bonds. They are traded in secondary markets and offer stable, income-producing opportunities but carry risks, notably highlighted during the financial crisis.

### Key Takeaways

*   Mortgage bonds are secured by real estate holdings, offering investors protection against defaults through underlying asset liquidation.
*   These bonds are generally considered safer than corporate bonds, which leads to typically lower yields.
*   The process of securitization transforms individual mortgages into bundled mortgage-backed securities sold on the secondary market.
*   Despite the financial crisis associated with subprime mortgage bonds, they remain an important part of financial markets for liquidity and investment.
*   Investors should evaluate the quality of underlying assets in mortgage bonds to assess potential default risks.

## How Mortgage Bonds Provide Security and Income

Mortgage bonds offer protection because they are backed by valuable assets. If there’s a default, bondholders can sell the property to recover their investment. Due to their safety, mortgage bonds usually offer lower returns compared to corporate bonds, which are riskier.

After a homeowner takes a mortgage, the lender often sells it to others like investment banks or GSEs. These buyers bundle these mortgages and create bonds backed by them. Homeowners' interest payments fund the yield on mortgage bonds. As long as most pay on time, mortgage bonds remain safe and reliable.  

## Weighing the Pros and Cons of Investing in Mortgage Bonds

Mortgage bonds generally yield less than corporate bonds since they are safer investments. However, bondholders can claim the homeowner's property if a mortgage defaults. If necessary, the property can be sold to pay bondholders. Mortgage bonds are also generally safer than stocks.

If a corporation defaults, corporate bond investors have little recourse. Thus, corporations offer higher yields to attract investors willing to take this risk.  

### $2.4 trillion

The amount held in mortgage-backed securities by the Federal Reserve as of March 20, 2024.

## The Risks and Lessons From Subprime Mortgage Bonds

One major exception to the general rule that mortgage bonds represent a safe investment became evident during the [financial crisis](https://www.investopedia.com/terms/f/financial-crisis.asp) of the late 2000s.

Leading up to this period, investors realized they could earn higher yields by purchasing bonds backed by [subprime mortgages](https://www.investopedia.com/terms/s/subprime-meltdown.asp)—mortgages offered to buyers with poor credit or unverifiable income—while still enjoying the supposed security of investing in collateralized debt.

Unfortunately, enough of these subprime mortgages defaulted to cause a crisis during which many mortgage bonds defaulted costing investors millions of dollars. Since the crisis, there has been heightened scrutiny over such securities.

The Fed continues to hold a large amount of [mortgage-backed securities](https://www.investopedia.com/terms/m/mbs.asp). As of March 2024, it held about $2.4 trillion in these assets, as reported by the Federal Reserve Bank of St. Louis.

## Do Mortgage Bonds Still Exist?

Yes, mortgage bonds still exist. While mortgage-backed securities (MBSs) had a bad image after the financial crisis in 2008 due to many MBSs consisting of subprime loans, MBSs are an important aspect of the financial markets. They provide liquidity, free up the balance sheets of banks, support the housing market, and provide investors the ability to invest in home real estate.

## Why Do People Buy Mortgage Bonds?

People buy mortgage bonds because they offer a higher return than government bonds. They may also provide higher yields than investment-grade corporate bonds depending on the credit rating.

## How Do Banks Make Money on Mortgage Bonds?

Banks make money on mortgage bonds by selling the mortgages they originate to mortgage aggregators or other investors. These mortgage aggregators bundle the mortgages into mortgage-backed securities and sell them to investors. Now that these mortgages are off the balance sheets of the banks, they can originate new mortgages to new lenders.

## The Bottom Line

Mortgage bonds offer a relatively safe investment due to their backing by real estate or real property, making them an attractive option for investors prioritizing security over high yields. They are less risky than corporate bonds, which lack collateral but typically offer higher returns.

It's crucial for investors to assess the quality and stability of the underlying assets in mortgage bonds to avoid potential defaults. A sound understanding of these factors can help in making informed investment decisions.

> **Article Sources**
>
> 1.  Federal Reserve Bank of St. Louis. "[Assets: Securities Held Outright: Mortgage-Backed Securities: Wednesday Level](https://fred.stlouisfed.org/series/WSHOMCB)."