What Is Securitization?

24
December

One financial term you may not be very familiar with is securitization. Securitization refers to a very specific financial practice. In short, securitization occurs when more than one debt instrument is combined together. This is done so these debt instruments can be sold together to produce a profit.

During this process of securitization, the different debt instruments that are collected together will have their total value converted into a bond. This bond can then be bought by different investors. This process will actually be facilitated by someone who set up as a trustee. The trustee will be the one who first purchases all the different debt instruments that will become part of the securitization investment. The trustee will also be the one who goes on to put the up bond for sale and offer it to different investors.

The debt instruments that can be combined during securitization can be very different from one another. The kinds of debt instruments that are grouped together can include things as different as credit card debt, loans on cars, and mortgage loans.

Due to how different these kinds of debt are from one other, you may be wondering what would tie them together enough to the point that they would become bundled together by the trustee. The one qualification that all debt instruments must meet to be considered for securitization is their ability to generate income. This income is often generated in cases where there has to be interest paid on the debt’s outstanding balance. It can also be created through payments that are made on the debt’s principle amount.

One of the most common forms of securitization is the pooling of mortgage loans. This form of securitization is especially popular among finance companies, banks, and investor groups. For a single debtor, transferring the debt can be a very simple process. The process for one may be completely transparent. Secondly, all that may have to be involved is the change of the address where payments on the debt can be mailed to. One good upside to securitization is the fact that the process will not lead to higher interest rates.

One of the greatest benefits of using securitization is that it creates investments that can produce a constant flow income over specific periods of time. When this process is done using mortgage loans, it is sometimes referred to as a mortgage backed security or an MBS for short. The individuals who invest in an MBS will receive a steady flow of cash that is produced by payments on the principal amounts and interest accrued by the original debtors who took out the mortgages. An MBS may include a number of different kinds of mortgages including both commercial and residential mortgages.

Despite the obvious advantages inherent in this kind of investment, there still is significant risk for any investors who partake. The risk is inherent in the debt instruments that make up the bond. There is always a chance that people who make credit card payments or mortgage payments could default on their loans.

However, the people who do invest in these kinds of securitization investments are also likely to take extra precautions to lessen the possible impact of these kinds of risks. One of these precautions simply exists due to the structure of the securitization. The securitization will bundle many different mortgages and other kinds of debt as well. The odds of all or most of the original debtors defaulting on their loans is statistically insignificant.

The second protection is likely to exist in the terms and conditions that the different investors agreed to in the contract they formed with the trustee who oversees the securitization. The contract will include promises that the trustee will take some kind of action to save the investment if a significant portion of the debtors involved default on their loans. These kinds of assurances help make securitization investments especially attractive investments.

This post was written by

jason – who has written posts on Budget Clowns.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.

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