A mortgage-backed security (MBS) is similar to a bond whose cash flows are backed by mortgage payments. In the United States, mortgages may usually be prepaid in their entirety at any time. This is called prepayment. This means that the duration of the cash flows is unknown, which makes an MBS more interesting than plain vanilla bonds. An MBS is an asset-backed security where the assets are mortgages.

There are many reasons for mortgage originators to finance their activities by issuing mortgage-backed securities. Mortgage-backed securities

1) transform relatively illiquid, individual financial assets into liquid and tradeable capital market instruments.

2) allow mortgage originators to replenish their funds, which can then be used for additional origination activities.

3) are frequently a more efficient and lower cost source of financing in comparison with other bank and capital markets financing alternatives.

4) allow issuers to diversify their financing sources, by offering alternatives to more traditional forms of debt and equity financing.

5) allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilize capital more efficiently and achieve compliance with risk-based capital standards.