Advantages & Disadvantages of Ginnie Mae Bond Funds
Ginnie Mae (GNMA) bond funds are a type of mortgage-backed security issued by the Government National Mortgage Association and are guaranteed by the full faith and credit of the federal government.
Essentially, investors fund a pool of mortgage loans, and returns are based on the repayment of principal and interest. There are both advantages and disadvantages to Ginnie Mae bond funds, and it is important to know what to expect before investing in them.
Guaranteed Return
Due to the structure of Ginnie Mae funds, there is a continuous outflow of cash, which is paid to investors monthly. While Ginnie Mae funds do not guarantee investors a specific yield, they do guarantee the timely payment of interest and principal of the mortgages held in the bonds. Generally, Ginnie Mae bond funds also carry a higher rate of return than other types of bonds, such as Treasury bonds.
Reduce d Risk
Although Ginnie Mae bond funds are mortgage-backed securities, because they are guaranteed by the federal government, investors are safeguarded from the risk of potential default by borrowers.
This means that even if a borrower is unable to make his payments, the federal government guarantees the repayment of principle and interest to investors. The liquidity of Ginnie Mae bond funds also makes it easier to resell them on the secondary market.
Market Fluctuations
Although Ginnie Mae bond funds provide a dependable monthly income in the form of interest payments, they are subject to market fluctuations, which can make them very volatile.
The price of Ginnie Mae bond funds increases or decreases inversely with increases or decreases in interest rates in the market. This means that the value of your initial investment can increase or decrease with changes in the market, which can potentially result in significant losses.
High Minimum Investment
Generally, the minimum investment for a Ginnie Mae fund is $25,000, and securities are sold in $1 increments afterward. It is possible to make a lower initial investment by purchasing Ginnie Mae funds on the secondary market if they carry lower interest rates or the principal has been greatly reduced. It is also possible to invest in Ginnie Mae mutual funds at a reduced cost, although these differ significantly from bond funds.
Prepayment Risk
When homeowners prepay their mortgages or refinance due to lower interest rates, it creates uncertainty in the regularity of payments to investors. When the number of mortgage prepayments increases, shareholders who choose to reinvest must do so at lower interest rates.
Because lower rates correlate inversely to bond prices, this means that investors have to pay more for their shares.
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