See: Mortgage.
You may have heard of a mortgage-backed security. They became famous during the financial crisis of 2007-2008. They were debt instruments (similar to bonds) that were backed by a group of home mortgages. Watch The Big Short if you haven't.
Wall Street banks bought tons of them during a housing boom of the early part of the 2000s, thinking they were safe investments. They were then stuck holding a bunch of them when the market collapsed, leading to a financial crisis and an eventual government bailout.
Mortgage pools provide the basis of mortgage-backed securities...like how batter provides the basis of a cake, or how water provides the basis of a wet t-shirt contest. A mortgage pool consists of a group of similar mortgages...borrowers with similar credit scores buying houses of similar values. These get bundled together (or pooled, if you'd rather). Then this big pile of mortgage debt becomes the basis of securities (those mortgage-backed securities we mentioned before), which can then be sold on the open market.
Having a mortgage pool provides some diversification, in that a single default by one of the associated homeowners doesn't cause a major threat to securities issued based on the pool. However, this diversification is limited.
All the mortgages in a pool are similar...that's part of the plan. They likely have the same risk, duration, geographic area, size, type of collateral (a house), color of paper used to sign the documents, etc. This means that all the mortgages will react in a similar way to market forces. An economic downturn that increases the number of home defaults will impact all the homeowners that contribute to the pool in the same way. It's like a school of sardines when a shark enters the area...they all turn the same direction at once.
Since everything reacts in a similar way to market influences, when things go bad, they go bad for all the pool contributors. In that case, it's not diversification. It's more like...gasoline on a fire.
Hence the issues that came up in the mortgage meltdown that led up to the 2007-2008 financial crisis. When the market turned, it turned for everyone in the same way. Many pools became completely toxic, because they weren't filled with completely independent actors. They were filled with a bunch of situations likely to react exactly the same to a bad housing market...i.e. with people who stopped paying their mortgages.
Related or Semi-related Video
Finance: What is Interest Only Mortgage?17 Views
Finance allah shmoop what is an interest only mortgage Well
simply put it's when you only pay the rent on
the dough you borrowed you don't pay down the principal
you owe like if you have a three hundred thousand
dollars mortgage at six percent interest you're paying eighteen grand
a year to rent that money in six percent times
three hundred rands eighteen grand a year But the principal
you borrowed is likely due in thirty years So in
theory anyway if it were a normal mortgage you'd want
to pay down the principal little bit a month as
you go along like averaging ten grand a year in
principle pay down over thirty years That's times ten grand
right three hundred grand their total owning your home at
the end yeah yeah priceless that's what holmes work So
why would you want an interest only mortgage Well for
one thing the monthly payments or less so maybe you
could afford morehouse If on a thirty year three hundred
thousand dollar loan at six percent you're paying interest only
while you're writing a check each month for eighteen thousand
divided by twelve or fifteen hundred bucks maybe that's all
You can afford well the extra five hundred bucks arm
or you'd right toe pay down your principles Just not
something you can really do right now Maybe after three
years of scrimping and saving well you'll be able to
start paying down that principal reducing risk and making life
easier all the way around But right now you can't
afford it so the only thing you can do is
do the interest only dance Well the other reason you
might want an interest only mortgages that interest costs are
tax deductible Principal pay down costs are not so if
in a given mortgage payment of say eighteen hundred bucks
a month where three hundred of it is principal pay
down and fifteen hundred of it is interest well on
ly the fifteen hundred is tax deductible That three hundred
of pay down is not And if you're a forty
percent taxpayer the government is essentially picking up the tax
savings on the fifteen hundred times a forty percent at
six hundred dollars in interest You're paying such that they
quote feel unquote like the fifteen hundred is really only
about nine hundred a month in cost to you the
three hundred bucks and principal paydown feels like a full
three hundred dollars So some people seeking tio optimize their
tax deductions live in the world of interest only mortgages
and let the government for a change You know work 00:02:26.24 --> [endTime] for them How's that feel same all Take it
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