What are nonagency mortgage-backed securities (MBS), and should I invest in them?

Investing in real estate is appealing for many people, but becoming a landlord sounds like a big hassle. If you want to get into the real estate investing market with a passive investment, mortgage-backed securities (MBS) may be a good fit.

An MBS is an investment that works like a bond, paying regular interest. Instead of being backed by a company or a government, an MBS is backed by a mortgage. Nonagency mortgage securities are a type of MBS that do not meet conforming loan requirements set by Freddie Mac and Fannie Mae. This can mean they carry slightly higher risks but also potentially greater returns.

If you’re interested in earning passive income and considering investing in a nonagency MBS, this article will break down what you need to know about the risks, potential rewards, how to invest, and who should consider investing in these securities.

What is a nonagency MBS?

Fannie Mae and Freddie Mac are government-sponsored enterprises tasked with keeping the country’s mortgage system running smoothly. They do this by buying loans from lenders that originate them, so long as those loans conform to the requirements the Federal Housing Finance Authority (FHFA) sets.

Because Fannie and Freddie must adhere to the FHFA requirements for these loans, the mortgages they buy have relatively similar features, making it easy to assess the risk and return of any MBS that contains these conforming loans.

An MBS that contains loans that do not conform to Fannie and Freddie’s requirements is a nonagency MBS. The loans in them could be higher risk or have unusual terms, which means higher risk. To compensate, they may offer better potential returns.

Mortgage-backed securities, explained

A mortgage-backed security is an investment based on mortgage loans. The owner of an MBS has a claim to the mortgage payments made by the people who borrowed money with the mortgages contained in the MBS.

Most MBSs contain a large pool of loans, typically ranging from a dozen to a hundred or more. That helps reduce risk because if one borrower defaults, the owner of the MBS still gets payments from the other borrowers.

Generally, these securities are created by government-sponsored enterprises. When a lender gives someone a loan, they will sell that loan to Freddie Mac or Fannie Mae. Those agencies will package multiple loans into an MBS and sell that MBS to investors.

This process lets the lender recover the money it lent out quickly, profiting on underwriting and closing fees. In return, the investor gets a security that produces a stream of income.

Agency vs. nonagency MBS

All MBSs are backed by mortgage loans, but there are key differences between an agency MBS and a nonagency MBS. An agency MBS is one that’s backed by a government agency such as Fannie Mae, Freddie Mac, or Ginnie Mae. Nonagency MBSs, on the other hand, are issued by private institutions and have no government agency guarantee.

There are also nonagency residential mortgage-backed securities (RMBS), which include only residential loans, with no commercial loans.

Potential risks of investing in nonagency MBSs

Investing in mortgage-backed securities comes with risk, and nonagency MBSs can be even riskier.

Nonagency MBSs do not have any government backing, so if a large number of borrowers default, the MBS will produce less income, and investors could even lose money.

The credit risk for nonagency MBSs is also usually higher than for agency MBSs. Conforming loans that go into agency MBSs have stricter underwriting requirements, while the loans in a nonagency MBS could have been offered to people with poor credit or who otherwise could not meet conforming loan requirements.

Investors got a clear look at the risk of investing in MBSs during the 2008 subprime loan crisis, when many homeowners were unable to make payments on their loans. In the nearly two decades since, laws like the Dodd-Frank Act, ability to repay (ATR) rules, and Truth in Lending Act have helped reduce, but not eliminate, this risk.

Potential rewards of investing in a nonagency MBS

Despite the risks, a nonagency MBS can be attractive to investors for a few reasons.

One key advantage is that they offer better potential returns than agency MBSs or traditional bonds. If you want to maximize your potential profits, you may want to consider a nonagency MBS.

For example, if a bond offers a 5% return and an MBS an 8% return, you could earn far more from the MBS over the life of the security.

They also offer diversification into the real estate market, which can be good for people who don’t otherwise have exposure to real estate.

Investing in an MBS also offers the opportunity to have a passive real estate investment rather than buying an investment property and becoming a landlord.

How to invest in a nonagency MBS

Mortgage-backed securities aren’t the most common type of investment, so getting started can be a bit tricky. Complicating matters further is the fact that direct investment in nonagency MBSs is generally limited to accredited investors and institutional investors. To invest, you’ll need to invest in a REIT, mutual fund, or bond fund offered by these investors.

Step 1. Understand your risk tolerance

Consider your risk profile and how much you’re willing to lose. Based on your answer, choose how much you are willing to risk in this investment.

Step 2. Decide how you’ll invest

Accredited investors can buy nonagency MBSs directly, while others will have to invest indirectly, such as by buying REITs or ETFs that track the performance of an institutional investor’s MBSs.

Step 3. Find a broker or financial advisor

If you don’t already have a brokerage account, compare a few options and open one. Not all platforms offer nonagency MBS or RMBS funds. Some may focus on only agency-backed securities.

Step 4. Consider your options

Compare your options by looking at things such as their fees and the risk profiles of the MBS you can invest in.

Step 5. Diversify

As with any investment, it’s important not to put all your eggs in one basket. Be sure to buy other investments such as stocks and bonds to keep your portfolio diversified.

Step 6. Monitor your investment

Keep a close eye on your investment and the overall market. Things like interest rates, trends in the housing market, and default rates can all have an impact on your returns, and you may want to change your strategy. Consult with a financial advisor on a regular basis to make sure the investment still fits your goals.

FAQ

Before you invest in a nonagency MBS, it’s important to make sure you understand how they work.

Are nonagency MBSs a good investment in 2025?

Nonagency MBSs can be a good investment for the right person. With high interest rates and a hot housing market, the returns they offer can be quite appealing so long as you’re willing to accept the risk.

Who regulates nonagency MBSs?

Unlike agency MBSs, nonagency MBSs are not subject to the requirements of government agencies. However, they are still regulated by the Securities Exchange Commission and must meet standards for information disclosure.

Can I buy nonagency MBSs in an IRA or retirement account?

Yes, you can buy nonagency MBSs in certain retirement accounts. For example, you can buy an ETF that tracks a company’s MBS investments through your IRA.

How are nonagency MBSs rated?

Nonagency MBSs are often rated by agencies such as Moody’s or S&P using a letter grade scale. Higher-grade MBSs will be less risky but tend to offer lower returns.

What’s the difference between RMBS and CMBS?

An RMBS is a residential MBS, meaning it holds mortgages on residential properties. A CMBS is a commercial MBS, so it holds commercial loans. Either an RMBS or a CMBS can be nonagency, but residential and commercial loans have very different features, so each tends to serve different investors. Consult with a financial advisor to determine which investment is right for you.

The bottom line: With greater risk comes the opportunity for greater reward

Investing in mortgage-backed securities lets investors get exposure to real estate without having to buy property. Nonagency MBSs have a higher risk than agency MBSs but offer potentially higher returns. If you’re able to handle the risk and want exposure to real estate investments, they may be a good fit for your portfolio.