What is a mortgage-backed security?

A mortgage-backed security is a type of investment that is created by pooling together a group of mortgage loans and then selling shares in that pool to investors. When homeowners make their mortgage payments, those payments are collected and passed on to the investors, providing them with a stream of income. This structure allows the risks and returns of holding mortgages to be shared among many investors, thus offering a way for them to invest in real estate indirectly.

This investment mechanism relies on the cash flows generated by the mortgage loans, which are secured by the underlying properties. Therefore, investors evaluate the quality of the underlying mortgage loans and the likelihood that homeowners will continue to make their payments, which can impact the returns on the securities.

The other options do not accurately encapsulate the nature of mortgage-backed securities. While they may relate to different aspects of real estate finance, it is the unique combination of pooling mortgage loans and providing a financial product that can be traded or held as an investment that defines mortgage-backed securities distinctly.