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Risks and rewards of Ginnie Mae investments

Whether you're a newbie or a veteran with years in the stock market, investing choices can be confusing. Michael Tate, a Sacramento, Calif., investment adviser, offers advice.

Whether you're a newbie or a veteran with years in the stock market, investing choices can be confusing. Michael Tate, a Sacramento, Calif., investment adviser, offers advice.

QUESTION:I have had GNMA mortgage bonds for over 10 years because I've always liked their safety and return. Is there a scenario where you could lose a lot of money with GNMA bonds, or are they relatively safe?

ANSWER: This question has been coming up more often lately as investors look for higher returns than Treasuries or CDs, but do not want to take a large degree of risk. But first, for those unfamiliar with Ginnie Mae (GNMA) types of investments, we should define them. The Government National Mortgage Association (GNMA or Ginnie Mae) is a wholly owned U.S. government corporation established in 1968. Ginnie Mae guarantees mortgage-backed securities (groups of mortgages that are resold to investors) issued by other corporations. It does not loan funds for the underlying mortgages but ensures that investors receive as income the principal and interest payments on mortgages.

Ginnie Maes are predominantly backed by single-family, 30- or 15-year fixed-rate mortgages and 1-year adjustable-rate mortgages. The mortgages in a pool have the same interest rate, maturity term and dwelling type. The U.S. government is pledged to paying out all amounts guaranteed by Ginnie Mae.

There are many positive factors associated with Ginnie Maes; however, I would focus on the risks associated with investing in mortgage-related securities. Each must be weighed against your risk tolerance.

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To answer your question about a rise in interest rates: You could lose money if interest rates rise. All mortgages in a particular pool have the same interest rate. When investing in a fixed-income debt security, the price will fluctuate inversely with interest rates. If you sell the security in the secondary market prior to maturity or redemption, you could sustain a capital loss from the rise in interest rates.

Other risks include:

--Inflation and the loss of purchasing power.

--Uncertainty of prepayments: Homeowners can repay their mortgage prematurely, which is often true when interest rates fall and homeowners refinance at lower rates. This can lead to differences in the estimated yields.

--Return of capital: The investor who purchases a mortgage-related security should be aware that the payment represents both earned interest income and return of invested funds. If you spend all of the payment, you are depleting your principal.

--Changes in government regulations: There is no guarantee that the U.S. Treasury's support of these securities will continue or take the same form in future years.

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