Z-bonds are the riskiest MBS because investors receive no cash payments for an extended period of time and thus may be more likely to be left holding the bag if the underlying mortgages default. However, the presence of Z-bonds also makes the senior tranches more secure -- after all, those tranches (and their investors) get the Z-bond's payments first. One advantage, however, is that the holder of a Z-bond does not face much reinvestment risk -- he or she will continue to accrue interest as the stated interest rate for the life of the bond (even though no cash payments may come immediately).
For investors, an MBS is much like a bond. Most offer semi-annual or monthly income, and this payment frequency enhances the compounding effects of reinvestment. However, it is important to note that payments that are part interest and part principal could be unfavorable to some investors, because with each decrease in outstanding principal there is a corresponding decrease in the amount of interest that accrues. For example, if a $50,000 Ginnie Mae with a 5% coupon would pay $208.33 ($50,000 x .05/12) in interest every month, but it might also pay $100 in principal. This means that only $49,900 is earning interest next month, and by the end of the year there may only be $48,800 earning interest. The return of principal could also vary depending on how quickly the underlying mortgages are repaid.
Prepayment risk is a large concern for MBS investors. When people move, for example, they sell their houses, payoff their mortgages with the proceeds, and buy new houses with new mortgages. When interest rates fall, many homeowners refinance their mortgages, meaning they obtain new, lower-rate mortgages and pay off their higher-rate mortgages with the proceeds. Like bonds, changes in interest rates affect MBS prices, but the change is exacerbated by the fact that MBS investors are more likely to get their principal back early. They might have to reinvest that principal at rates below what their MBS were yielding.