For 3) it's a bit more complex than what you described. Mortgages are generally securitized. High level, a pool of unrelated mortgages (think different parts o

For 3) it's a bit more complex than what you described. Mortgages are generally securitized. High level, a pool of unrelated mortgages (think different parts of the US, different types of borrowers, different credit ratings) are packaged up together and then split into different tranches. Say you have tranches AAA-B. These different tranches are sold to different parties with different risk appetites. Each tranche has a set interest rate, and AAA will have the lowest, and B the highest. Say like 2.5% for AAA and 7.2% for B. AAA is the most "senior" and B the most "junior". When borrowers pay back their monthly payments, first the interest gets distributed to AAA->B, then all the excess goes back paying the principal of AAA. Once AAA is fully paid back (say 5 years later for a 30 year loan), the AAA bondholders no longer care about the mortgage, and the excess gets paid towards AA principal (then A, BBB etc). This keeps going on until every tranche gets fully paid back. By structuring it this way it's "almost impossible" for the more senior bondholders to realize a loss. Obviously there is more risk for B bondholders (given they are being paid 7.2% interest). So in this case, losses in mortgages are borne by B principal holders until they get exhausted. Zooming back into the pre-payment risk, it's entirely possible that prepayments/refinances will allow the more junior tranchess to avoid as much principal loss as expected while picking up that juicy yield. (note when the yield for more junior bonds are 7.2%, anyone buying these already planned for some amount of realized losses) This pic from wikipedia illustrates some of the concepts https://en.wikipedia.org/wiki/Tranche#/media/File:Risk&ReturnForInvestors.svg https://en.wikipedia.org/wiki/Tranche#/media/File:Risk&Retur...