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A Guide to Understanding Ginnie Mae Bonds

written by: Tim Plaehn•edited by: Jason C. Chavis•updated: 6/28/2011

Ginnie Mae bonds provide a government guaranteed payment of interest and principal. Investors can earn a higher yield than with Treasury notes or bonds but should understand the unique features and risks of Ginnie Mae bonds.

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    Government National Mortgage Association

    Ginnie Mae bonds are mortgage backed securities -- MBS -- insured by the Government National Mortgage Association, also known as GNMA or Ginnie Mae. Ginnie Mae provides investors with MBS bonds that are guaranteed by the U.S. government for the payment of principal and interest.

    Ginnie Mae does not issue bonds. Ginnie Mae bonds are produced by a bank or financial institution that pools mortgages with the same characteristics and divides the pool into investment bonds for investors. Ginnie Mae guarantees the payments from the mortgages in the specific mortgage pools. The mortgages backing a Ginnie Mae bond will be home loans guaranteed through the FHA or VA home mortgage programs.

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    How a Ginnie Mae Bond Works

    Ginnie Mae bonds are direct mortgage pass through securities. This means that as the homeowners with mortgages in the pool of a specific bond make their home loan payments, those payments are paid each month to the Ginnie Mae bond holders in the same proportion as the investors size of bond face amount and how much the pool received in payments. The result is that a Ginnie Mae bond holder will receive a payment every month that consists of interest on the bond and a partial repayment of principal. Over time, the principal value of the bond will be paid down and the interest amount received each month will decrease.

    A Ginnie Mae bond may be a portion of a pool of 30 year mortgages but the effective life of the bond will be significantly less than 30 years. The average maturity of a Ginnie Mae is typically 5 to 12 years, depending on the interest rate of the mortgages in the pool. The expected payoff time of a mortgage backed security will change based on how fast the homeowners paydown or refinance their mortgages.

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    Ginnie Mae Investment Considerations

    The federal government guarantee for the payment of principal and interest on the mortgages in a Ginnie Mae bond pool result in Ginnie Maes being considered one of the safest investments, right after U.S. Treasury securities. Ginnie Mae bonds will usually have a yield that is slightly higher than comparable Treasuries. A point to remember is that the interest earned from Treasury securities is exempt from state income taxes but the interest from a Ginnie Mae bond is state taxable income.

    The flexible nature of the repayment of principal from a Ginnie Mae is the biggest risk. Extension risk happens if rates increase and the homeowners in the pool elect to hang on to their low rate mortgages for as long as possible. A Ginnie Mae investor will see the expected maturity of his lower rate bond extend as interest rates rise. If rates decrease, homeowners may elect to refinance the loans it the pool, returning principal to the investors at a faster rate. The returning principal will be reinvested at the current, lower rate.

    A Ginnie Mae mutual fund may be the most appropriate vehicle for an investor to participate in the Ginnie Mae market. A mutual fund will automatically strip out the principal portion of the bond payments and reinvest it into more bonds. The dividends a Ginnie Mae mutual fund investor receives will reflect only the interest earned from the bonds.

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    Ginnie Mae: For Investors,

    Fidelity: Mortgage Backed Securities,