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People who may have been unemployed as far as the lender knew received loans for hundreds of What are the release dates for Designed to Sell – 2004 Downsizing to a Condo? thousands of dollars. One answer is that, with the introduction of MBSs, lenders no longer assumed the risk of a loan default. They simply issued the loan and promptly sold it to others who ultimately took the risk if payments stopped. And since MBSs created early on were based on mortgages granted to the more dependable prime borrowers, the securities performed well. They performed so well that investors clamored for more.
Prior to the first decade of the 21st century, it was customary for a U.S. This changed after the mortgage-backed security (MBS) was introduced. These are borrowers with low credit ratings who pose a high risk of defaulting on their loan. But lenders of all stripes bent over backwards in the early 2000s to get this type of borrower into homes. So banks turned to customers they’d traditionally shunned — subprime borrowers. Eventually, the most desirable, qualified customers dried up; they all had homes. Banks wanted to know all about an applicant’s financial stability — income, debt, credit rating — and they wanted it verified. The no-document loan was created, a type of loan for which the lender didn’t ask for any information and the borrower didn’t offer it.
Mortgage-backed securities (MBSs) are simply shares of a home loan sold to investors. The larger bank then issues shares of this security, called tranches (French for “slices”), to investors who buy them and ultimately collect the dividends in the form of the monthly mortgage payments. These tranches can be further repackaged and sold again as other securities, called collateralized debt obligations (CDOs). They work like this: A bank lends a borrower the money to buy a house and collects monthly payments on the loan. This loan and a number of others — perhaps hundreds — are sold to a larger bank that packages the loans together into a mortgage-backed security.
In response, lenders loosened their restrictions for mortgage applicants and borrowed heavily to create cash flow for loans in order to create more mortgages. Without mortgages, after all, there are no mortgage-backed securities. Interest-only derivatives divided the interest payments made on a mortgage among investors. If rates fall and homeowners refinance, then the security loses value. The investors in MBS faced the same risk and reward system that the old lender-borrower relationship was subject to, but on a much larger scale due to the sheer volume of mortgages packed into a MBS. If interest rates rise, the return is good. After MBSs hit the financial markets, they were reshaped into a wide variety of financial instruments with different amounts of risk.
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