One of the most popular income investments these days is the Ginnie Mae--a security offered by the Government National Mortgage Association. It's paying 12.3 percent compared with 10.6 percent on comparable Treasuries and is directly guaranteed by the federal government. A Ginnie Mae is a type of mortgage investment known as a pass-through security, and it works like this:
A home buyer takes out a mortgage and pledges his house as collateral. The bank or S&L that gave him the mortgage pools his loan with others bearing the same term and interest rate, to create a package of mortgages worth $1 million or more. Ginnie Mae checks to be sure that all the mortgages in the pool meet certain standards and then issues its guarantee. Stockbrokers sell participations in the pool to individual investors.
The home buyer continues to make his monthly payments of principal and interest to his bank or S&L. The bank, however, does not keep the money. It deducts a handling fee and a Ginnie Mae insurance fee and passes the remainder on to the investors, in proportion to their participation in the pool. Any prepaid mortgages are similarly distributed. That's why it's called a pass-through security. All principal and interest payments made by the mortgage holders are passed through the bank to the investors.
Ginnie Mae mortgage pools are written for 30 years. But most homeowners sell their houses sooner and prepay their mortgages, which brings the average life of a Ginnie Mae to about 12 years. When only a small number of mortgages remain outstanding, they will probably be sold and the proceeds delivered to investors.
As an investor, you get a check from your Ginnie Mae every month. But it isn't the usual sort of check you'd expect from an income investment, which normally pays only interest. Each Ginnie Mae payment is made up partly of taxable interest and partly of mortgage principal, the latter being a nontaxable return of your own, original capital. So if you spend each month's check, you are spending your principal as well as the interest it earned.
A retired person might want to spend all or part of his principal every month. But a younger investor should reinvest the proceeds or put them in the bank, so that his or her capital can grow.
Your monthly payment is different in another way: It varies in size. In a month when a mortgage in the pool is prepaid, you'll get a bigger check. When none is prepaid, you'll get a smaller check. Older Ginnie Maes, whose mortgages carry lower interest rates, are being prepaid a bit more slowly than expected, so the checks may be smaller than some retired investors had counted on. Ginnie Maes written when mortgages were at 16 percent are being repaid faster, so checks are larger.
If you buy a Ginnie Mae whose underlying interest rate is more, or less, than current rates, your actual yield will depend on how fast the mortgages in the pool are prepaid. The assumed yield is based on a 12-year payout. But if the pool contains high-interest mortgages that are prepaid sooner, your yield would be a little less than originally expected, according to Norman Schvey, director of the bond-fund division at Merrill Lynch. If the pool contains low-interest mortgages that are paid off more slowly, your yield would also be lower. Reverse the conditions and your yield would be higher.
You can buy Ginnie Maes three ways: a direct participation for $25,000, a share in a unit trust for $1,000 or a share in a mutual fund, also for $1,000.
Unit trust is a fixed pool of Ginnie Maes broken down into $1,000 units, paying a pro-rata share of principal and interest. You can generally sell your shares before maturity, at current market value. The newer unit trusts combine high and low-rate mortgages into a single investment. "I can get a higher yield by combining 8 percent mortgages with 16 percent mortgages than I can on straight 12 percent mortgages," Schvey says. Sales charges vary. Merrill Lynch's is 3.5 percent.
A mutual fund, by contrast, is not a pass-through security. The fund itself receives the interest and principal payments. You own a share in the fund, which pays dividends and whose market value can change daily as interest rates rise and fall. When short-term rates rise, the fund's yield will rise, but its shares will lose value. When interest rates fall, the fund's yield will fall, but its shares will gain value. The mutual fund stands ready to redeem your shares if you want to sell.