Pluses and Minuses of Ginnie Maes

QUESTION: Some of my friends are investing in Ginnie Maes. But none of them have yet been able to give me a good explanation of what Ginnie Maes are and why, if they’re so safe, the going yield on them is somewhat higher than the supposedly safe government securities that I have. Can you explain?--P.K.

ANSWER: Your confusion is understandable. The 17-year-old Government National Mortgage Assn., the government authority that guarantees these securities, says that even otherwise sophisticated investors don’t completely understand these issues.

A Ginnie Mae is a share in a pool of mortgages. By investing in these securities, you are lending money for people to get mortgages on their homes.

Imagine that a dozen of your neighbors all went to a savings and loan and took out mortgage loans on their homes. After making those loans, the S&L; would have far less money available to make more home loans. So, it might bundle up those mortgages made to your neighbors--say the whole lot is worth $1 million--and sell them to the government.

Then, this package of loans is further split up--usually into $25,000 shares called Ginnie Mae pass-through certificates--and sold off to investors like your friends. The Government National Mortgage Assn., also called GNMA or Ginnie Mae, guarantees that these investors will receive a portion of the principal and interest from these mortgages every month even if the individual payments on the mortgages in that pool aren’t made on time. The mortgages in the pool back up the Ginnie Mae guarantee.

In this way, the government stimulates home buying and mortgage lending. Since the mortgage-backed securities program began in 1970, Ginnie Mae has guaranteed more than $125 billion in securities.

So why does a Ginnie Mae--currently yielding about 12% or 12.5%--generally offer a yield as much as a point or two higher than other federally backed securities? The GNMA says it’s because the amount of the monthly payment received by Ginnie Mae investors isn’t fixed and may fluctuate substantially. And because of that, there is no assurance that the investment won’t be fully exhausted before the cited maturity date.

During periods of comparatively low interest rates, when homeowners are hurriedly refinancing their home loans before rates bounce back up, Ginnie Mae investors will get back more principal than they expected. Why is that bad? Because it’s highly unlikely that they will be able to reinvest that money at the same high rate that they got when they bought the Ginnie Mae.

Remember, these are mortgage pass-throughs. Just as you pay off both principal and interest on your loan every month, so, too, the borrowers whose mortgages back your Ginnie Mae securities are paying off principal and interest. Those payments are passed along to the investor. On top of that, if one of the mortgages in that pool backing up your securities is paid off early or refinanced, a share of that will be passed along to the investors as well.

Say you invest in a $25,000 Ginnie Mae, yielding 12.5%. Your first monthly check would include about $260 in interest--slightly more than 1%--and $5.75 in principal. This would continue as the months go by, with the interest you receive tied to the remaining principal. But if any of the mortgages in the pool backing your certificate are paid off early or refinanced, your monthly payment would also include an amount representing a share of that.

That is why, when your securities mature--typically in 12 years, since that is the actual life of an average mortgage--you won’t get back your full $25,000. You have been getting parts of it back, represented by the principal, every month.

Since the Ginnie Mae doesn’t guarantee reinvestment at the same yield you locked in when you bought the pass-through certificate, investment advisers often caution against these issues, particularly for younger persons--particularly during periods of high interest rates. There is a good chance that a lot of the mortgages will be refinanced a few years later and the investment will fully exhaust itself well before the investor expected.

Conversely, these are considered good investments for retired persons. Retirees are provided a monthly income for a period that often coincides with their life expectancy.

Another advantage of Ginnie Maes is that there is a strong secondary market for them in the event that you need to sell out before the certificate matures. The going prices for buying and selling are listed in many daily newspapers under “government agency issues.�

To invest in a single Ginnie Mae requires at least $25,000. Certificates may be purchased in increments of $5,000 over the $25,000.

But smaller investors may participate in these investments, too, by buying Ginnie Mae unit investment trusts for as little as $1,000. These trusts pool together the money from a lot of people and invest in Ginnie Maes. They offer slightly lower yields.

Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business Section, The Times, Times Mirror Square, Los Angeles 90053.