A mortgage-backed security is a term that became popular during the global market crash of 2008 that dragged big financial institutions like Lever brothers, and Fannie Mae under.
How do Mortgage-backed securities work?
Let’s paint a scenario to explain what this term means to a layman – Assuming you want to buy a house and would like a certain percentage of the cost to be financed by mortgage or home equity from ABC bank. ABC bank paid the money into your savings account after accepting the terms of payment – you agree to repay the loan (with interest) within a certain period.
To ABC bank, the mortgage loan portfolio (which comprises the principal and interest payment receivable over a set schedule) is an asset which will be treatment under “Loan & Advances” in the statement of financial position.
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Accounting entries for mortgage in the ABC bank
DR Loan & Advance account (mortgage) and CR bank account with the amount transferred to the customer.
DR Loan & Advance account and CR interest income owed account with the value of interest income receivable over the years.
ABC bank may choose to hold the loan in its portfolio or package the mortgage and sell it to another company XYZ so that it can raise more cash to advance loan to other customers.
Accounting entries for sales of mortgage:
DR your bank account and CR the “Loan & Advances account (mortgage) & interest income account with the cash received from the sale of the mortgage to XYZ company.
XYZ Company groups you mortgage with similar mortgages purchased from other banks – these group are based on similar interest rates, maturities etc.)
Accounting entries for XYZ company on mortgage loan purchases from different companies:
Cr the bank account and DR “asset account (mortgage) with the amount paid on purchases.
The selling of securities representing an interest in the group of these mortgages bought from different banks is called securitization. These mortgages are sold to investors while the cash from sales proceeds is used to buy more mortgages to create mortgage-backed securities.
According to Wikipedia, “A mortgage–backed security (MBS) is a type of asset-backed security that is secured by a mortgage or collection of mortgages. The mortgages are sold to a group of individuals (a government agency or investment bank) that securities, or packages, the loans together into a security that investors can buy.”
Accounting entries for sales of mortgage-backed securities in XYZ book:
DR the bank account and CR long-term liability account (mortgage issued as security) with the value of the mortgage-backed securities. Don’t forget that there is interest payable to investors in the mortgage-backed securities, DR the long-term liability (mortgage) to reduce the payable balance and CR your bank with the interest and the principal portion of the security.
Hope you find this accounting entry for mortgage-backed securities useful? Read more tips on accounting treatment for business transactions here
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