Mortgage securities allow lenders to recover much-needed capital to lend to new borrowers.
Mortgage securitization developed in the 1970s, when lenders began creating pools of mortgages and selling them to government-backed agencies such as Ginnie Mae, Freddie Mac and Fannie Mae. These agencies guaranteed the projected income from these pooled mortgages and sold them as mortgage-backed securities to investors interested in stable long-term income. These securities became so popular that private companies began to buy up mortgages and package them as securities, as well. By the mid 2000s, originating lenders kept very few mortgages—most were packaged and sold within the first few months after origination.
One danger of the widespread prevalence of mortgage-backed securities is that since lenders did not hold onto the mortgages, they were not responsible for the long-term stability of the loan. As credit standards lowered during the 2000s, lenders were able to spread these high-risk loans among higher-quality loans and remove their liability, which prompted them to make even more high-risk loans. Eventually securities purchased by insurance companies, pension funds and mutual funds contained a significant amount of these high-risk loans. When the housing market collapsed, homes lost large portions of their value and homeowners began defaulting on their mortgages, causing these securities to lose a great deal of their value and creating huge investor losses.
Lenders also saw the disadvantages of mortgage-backed securities, since they had to get rid of low-risk, profitable loans in order to balance out the high-risk loans they included in these pools. As the losses mounted, the credit ratings of these lenders decreased as well, and they had few quality loans left in their portfolio. This drop in credit rating made it harder for them to get funds, and they had to slow down or stop lending, causing some lenders to go out of business.
Ginnie Mae, Freddie Mac and Fannie Mae, who guaranteed many of these securities, paid out large sums of money to cover the losses on these securities. The losses became so bad that a government bailout was required. This bailout cost taxpayers billions of dollars.
Homeowners also lose out from mortgage-backed securities, since the buying and selling of their loan is a continual process. A mortgage loan may change holders several times over the course of its term. Each time the loan is sold and purchased, there is the potential for problems with title, escrow and account information. Your property taxes and homeowner’s insurance may go unpaid because the bill was sent to the wrong mortgage servicing company. Your escrow account may not transfer properly, and you could lose funds. Your loan terms or account number could be recorded improperly, which could lead to billing problems. It could also create difficulties with a smooth chain of title and affect your ability to sell your home.
Bramble, Laura. "The Disadvantages of Mortgage Securitization." Home Guides | SF Gate, http://homeguides.sfgate.com/disadvantages-mortgage-securitization-6613.html. Accessed 19 April 2019.