GNMA stands for the Government National Mortgage Association, although it is more commonly known as Ginnie Mae. This government agency insures mortgage-backed securities that investors may purchase. Because the bonds themselves cost at least $25,000, individuals typically invest through GNMA mutual funds, which invest primarily in GNMA bonds. Ginnie Mae bonds come with government guarantees that ensure a degree of security.
Although the phrase "mortgage-backed security" can scare a lot of investors off because of the volatility of the housing market and the high rate of foreclosure that followed the 2008 banking scare, GNMA bonds are different. They are guaranteed by the federal government, meaning that even if the borrower from a mortgage fails to pay, the government will step in and pay the interest due on the bond. Therefore, investors may view GNMA bonds as having the full faith and credit of the U.S. government, just like Treasury bonds.
Interest Rate Risk
The major risk when investing in a fund that purchases GNMA bonds is that the value of the bonds may drop significantly if market interest rates rise. This is because investors will want to purchase new GNMA bonds that pay higher rates, so older bonds that pay lower rates will have to sell at a loss from face value. Therefore, although the interest rate on the bond is guaranteed, this rate is not necessarily the best possible one for the duration of the bond.
Because GNMA bonds are backed by a specific group of mortgages, the bonds are callable at any time if the borrowers prepay their mortgages. This means that rather than getting a relatively high interest rate on the bond for the full duration of its life even as market interest rates fall, your bond principal may be paid back to you as mortgage borrowers refinance at lower interest rates and pay off their old loans. This is known as calling the bond, and it makes the bond less secure than one that is guaranteed to last for a full 30 years, such as a Treasury bond. When GNMA bonds in a fund are paid off, the fund owner must then invest in new GNMA bonds, which may have a lower interest rate than the ones that were paid off.
GNMA funds are only slightly riskier than those that invest primarily in government bonds, but they have historically shown a return about 0.5 percent higher than government bond funds because of the risk of early repayment. This slight increase in risk is worth the return for many individuals. Because the bonds are backed by the government, they are much less risky than corporate bonds, so a GNMA fund can be a safe investment when compared to funds that invest in corporate bonds and stocks. Because of the decreased risk, however, GNMA funds generally don't have returns as high as those of funds with riskier investments.
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