When a mortgage lender makes funds available to a borrower, the debt is secured on the borrower’s home, which can be seized later and sold should things go wrong. By extension, the mortgage itself can be securitised.
This involves the lender grouping say £100m of existing mortgages together – remember that a mortgage simply represents income received over say 25 years – and then creating and selling £100m bonds (IOUs) to willing investors.
These investors know that the future mortgage receipts act as security for the bond’s interest and capital repayments. Meanwhile, the bank that created and sold the bonds has raised £100m cash that can be invested straight away, in place of having to wait for payments from its mortgage borrowers.
The principle doesn’t stop with mortgages – a football club could ‘securitise’ its next 20 years of gate receipts by selling bonds secured on them in order to finance a shorter-term project like the construction of a new stadium.