Based on a conversation I had over the weekend, I thought I would share some information gathered about the popular GNMA (Ginnie Mae) bonds.
Most investors have heard of Mortgage Backed Securities (MBS) because they have been the cause of many problems over the last year. GNMA Bonds are also MBS’s, but what makes them different from other MBS’s is that they are backed by the “Full Faith and Credit: of the United States Government.”
While this is a great benefit to have and makes these particular bonds much safer than other MBS’s, that does not mean they are not without their own risks. The government backing solves one of the bigger risks tied to MBS’s recently, default risk, but investors are still exposed to two other important risks - interest rate risk and term risk.
For Example: An investor may look to a 3 year GNMA and find a yield much higher than a similar 3 year Treasury, BUT there is not guarantee that a 3 year GNMA will actually mature/pay out in three years, in fact it is highly likely a 3 year GNMA bond will eventually pay out over a much longer time frame due to the way a GNMA is paid back, from Mortgage refinancing. With Mortgage rates at extremely low levels, if rates rise, refinancing may slow, turning a 3 year GNMA into a much longer maturity instrument AND exposing the investor to future principal and interest rate risk.
Investors should review these risks because of the higher yield these GNMA bonds pay. Remember that there is no such thing as a free lunch, and that yield is equivalent to the risk one has to take for the investment. The higher yield may pose an immediate satisfaction at a much greater risk in the future.