What are the best ways to invest in mortgage-backed securities (MBS)?

Mortgage-backed securities (MBS) are debt obligations that represent ownership of an undivided interest in a group of mortgages. Mortgage loans are bought from banks, mortgage companies and other loan originators, and then assembled into pools by various government or private entities. The entities subsequently issue securities, which are then purchased by private investors, that represent claims on the principal and interest payments made by borrowers on the loans that comprise the pool, a process known as securitization.

Most mortgage-backed securities are issued by Ginnie Mae (the Government National Mortgage Association), Fannie Mae (the Federal National Mortgage Association) or Freddie Mac (the Federal Home Loan Mortgage Corporation), all U.S. government-sponsored enterprises. MBS from Ginnie Mae are backed by the full faith and credit of the United States, which guarantees that investors receive full and timely payments of principal and interest. Fannie Mae and Freddie Mac MBS are not backed by the full faith and credit of the U.S. government, but both have special authority to borrow from the U.S Treasury if necessary. Other private institutions, including brokerage firms, banks and homebuilders securitize mortgages; these products are known as "private-label" mortgage securities.

Mortgage-backed securities can be purchased at most full-service brokerage firms and some discount brokers. The minimum investment is typically $25,000; however, there are some MBS variations (collateralized mortgage obligations, or CMOs) that can be purchased for less than $5,000. Investors who don't want to invest directly in a mortgage-backed security but who want exposure to the mortgage market may consider mortgage funds - exchanged-traded funds (ETFs) that invest in mortgage-backed securities. Examples include SPDR Barclays Mortgage Backed Bond ETF (MBG); iShares MBS ETF (MBB), and Vanguard Mortgage-Backed Securities Index ETF (VMBS). ETFs trade just like stocks on regulated exchanges, and can be sold short and purchased on margin. And, like stocks, ETF prices fluctuate throughout each trading session in response to market events and investor activity.