Mortgage-backed securities I | Finance & Capital Markets | Khan Academy

Mortgage-backed securities I | Finance & Capital Markets | Khan Academy

Welcome to my presentation on mortgage-backed securities. It will be a series of presentations, because what is happening in the credit markets is significant from the point of view of personal finances, and from a historical point of view. I will make some videos to see how it all fits together and what the consequences may be. Let's start with the basics. What is a mortgage-backed security? Let's look to the past. I took out a house loan, let's say 20 years ago. I will simplify some things. Let's say I need $ 100,000. Rather, let's say $ 1 million, which is closer to today's home price. I need a $ 1 million loan to buy a house.

It will be a mortgage covered by my house. So I'll borrow $ 1 million from the bank and if I can't repay the loan, the bank will get my house. Often I will only be covered by the house, it would be enough to give them the keys, the house will be theirs, I without obligations … and a good name. But I need $ 1 million. The traditional way to get a loan is to go to a bank interview. This is a bank. They have money there. They give me 1 million and I will pay them interest. I'll come up with an interest rate. Interest rates are changing. We will show the reasons another time.

Let's say I pay them 10% interest. Simply put, I assume that only interest is paid on the loans. With a traditional mortgage, your payments are consisting in part of interest and in part of principal payments. Math is a little harder here, therefore we will assume that I pay only interest and at the end I repay the entire amount of the loan. Let's say it's a 10-year loan, so I'll pay for each of the 10 years $ 100,000 in interest. Then, in the 10th year, I pay $ 100,000 and I'll also return $ 1 million. Years 1, 2, 3, …, 9, 10. So in year one, I pay $ 100,000. Year two, I pay $ 100,000. Year three, I pay $ 100,000. … Year nine, I pay $ 100,000. Year 10, I pay 100,000 plus I return 1 million. So in year 10, I'll pay back $ 1.1 million. This was the way the money traveled between me and the bank. This is the loan other than a mortgage-backed security. It is important to note that the bank keeps the loan. My payments went directly to the bank. This is how banks have traditionally done business.

Another person, say you – has a hat and you are extremely rich – – You deposit $ 1 million into the bank. Your savings or inheritance. The bank will pay you, for example, 5%. Then he takes the $ 1 million, gives it to me and gets 10% from what I just borrowed. The bank thus makes the difference. He pays you 5% and receives 10% from me. Later we can see how they do it, or what happens when withdrawing money, etc., etc.

bank

It's important to note that my payments went to the bank. This was the case before the mortgage-backed securities industry developed. The following is an example of mortgage-backed securities. This is still me. They still exist and I still need 1 million. I still go to the bank. The bank is still here. As before, the bank will give me $ 1 million. And then I give the bank 10% a year. As before. But before that, the bank kept these payments. The $ 1 million she had is now used for my house. Now comes the innovation. Instead of the bank having more deposits, to be able to lend more, sold these loans to a third party. Confusing, though? How can you sell a loan? Well, let's just say this is me. And there are thousands like me. We all borrow money at the bank. There are thousands like me. Together we borrowed a thousand times a million. So we borrowed 1 billion from the bank together. Of this, we pay 10% on interest. We will pay 10% of that billion, or 100 million in interest. So that 10% equals $ 100 million. The entire 1 billion the bank had is now in people's pockets. Let's say I want to borrow more money.

The bank will therefore take all the loans together, that is, $ 1 billion, and offer their investment bank – another bank- – For 1 billion. So the investment bank will give her $ 1 billion. Instead, me and thousands of others paid to the bank, we now pay to the new party. Complicated, though? So what happened? When the bank sold the loans, it merged them and sold to an investment bank. The investment bank paid 1 billion for the right to interest and principal payments. So this one got cash here and this bank gets the installments. Why did the bank actually do that? Apparently for fees or just advice giving loans to their customers. Who knows. The correct answer is that he receives fees for it. It may even shift a smaller value here.

I hope you now understand the concept of loan transfer. This one applies here and money will flow to this. I only have two minutes left, so next time I will focus on what can Do this here with a loan to turn it into a mortgage-backed security. And this one is an investment bank, not a commercial one. This is not so important for understanding which is a mortgage-backed security. We will learn more about this in the next presentation. Until early vision..

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