Why GNMAs pay a higher rate:
GNMAs are mortgage backed securities that are packaged and guaranteed by the Government National Mortgage Association. Unlike Fannie Mae and Freddie Mac, the Ginnie Mae has always been a government entity, with essentially no default risk.
Why GNMAs historically pay higher yields than Treasuries:
I’m not a believer that financial markets are philanthropic, so the extra yield likely comes with extra risk. And the extra risk that the investor takes on with these bonds is the fact that, unlike U.S. Treasuries, the exact timing of cash flows is unknown. That’s because, when interest rates go down, people refinance their mortgages and these securities are paid off. Conversely, when rates go up, the refinancing boom grinds to a halt and they are paid off more slowly.
So this pipeline of refinancing when interest rates drop means the GNMA investor will have less upside since people will be paying off those mortgages. But GNMAs have the downside risk if rates increase since the securities will sell at a discount. Thus, the higher yield is compensation for more downside principal risk and less upside potential.
Moneywatch columnist Larry Swedroe is not a fan of GNMAs. He likens them to a Treasury bond with put and call options to try to squeeze out a premium. He states he doesn’t see any evidence that call risk has been rewarded anywhere.
The Government National Mortgage Association (GNMA) operates as an agency of the U.S. Department of Housing and Urban Development.
It buys home mortgages from the financial institutions that made these loans and groups them into pools of $1 million or more. Ginnie Mae either keeps these pools to sell directly to investors or sells the pools to mortgage bankers and other institutions, which market them to investors.
Ginnie Mae or the mortgage banker continues to collect mortgage payments from the homeowners in each pool, and when you invest in a Ginnie Mae, you usually receive a monthly payment that includes both interest and a portion of the outstanding principal. Alternatively, you may receive monthly payments including only interest, and then receive the principal back when the mortgage matures.
These government agency bonds are also sometimes called Ginnie Mae pass-through securities, since the mortgage payments pass through a bank, which takes a fee before passing the remainder of the payments to investors.
Besides providing a higher return than Treasury notes and having the U.S. government’s backing against default, Ginnie Maes have another advantage: they are highly liquid and can be resold on the secondary market.
The minimum investment for a Ginnie Mae is generally $25,000. Thereafter, the securities are available in increments of $1. Of course, you sometimes can buy Ginnie Maes that are selling for less than $25,000 at a discount on the secondary market, if their interest rates are low compared to more recent issues or if their principals have been substantially reduced. Finally, you can purchase shares in Ginnie Mae mutual funds for less than $25,000. Ginnie Mae funds or investment trusts buy these government agency bonds and offer shares to the public.
In addition to individual investors, a wide variety of organizations buy Ginnie Maes–for example, retirement pension funds, credit unions, real estate investment trusts, commercial banks, insurance companies, and corporations. Likewise, many different types of institutions issue Ginnie Maes–including mortgage companies, banks, and credit unions.
