When can mortgage-backed investments become very risky?

Mortgage-backed investments can become very risky when they are backed by subprime mortgages. Subprime mortgages are loans made to borrowers with poor credit histories or lower credit scores, which increases the likelihood of default. When these borrowers struggle to make their mortgage payments, the underlying assets—represented by the mortgage-backed securities—can lose value significantly. This heightened risk can affect the return on investment and lead to substantial financial losses for investors.

In contrast, conventional mortgages are typically granted to borrowers with better credit profiles and therefore carry a lower risk of default, making them a relatively safer backing for mortgage-backed investments. Holding these investments for more than 12 months or having high interest rates does not inherently increase their risk compared to the nature of the underlying mortgages. The quality of the loans backing the investment is a critical determinant of its risk level.