Mortgage Investments
Mortgage-Backed Securities
Mortgage Investments include a variety of options. Mortgage-backed securities
are investments in a portfolio of home mortgages and are sometimes referred
to as "pass-through"
securities because homeowners’ mortgage principal and interest payments
are "passed through" to investors. The most well-known mortgage-backed
security is the Ginnie Mae, which is issued by the Government National Mortgage
Association (GNMA). Ginnie Maes carry the "full faith and credit" guarantee
of the federal government. Ginnie Maes require a $25,000 minimum purchase,
with $5,000 increments, from brokers, but can also be purchased indirectly
for $1,000 through units in a Ginnie Mae unit investment trust. They can also
be purchased through mutual funds that invest in U.S. government agency securities
(minimum amounts vary per fund).
Two other mortgage-backed securities that are not backed by the federal government
are Freddie Macs, issued by the Federal Home Loan Mortgage Corporation (FHLMC)
and Fannie Maes, issued by the Federal National Mortgage Association (FNMA).
They also require $25,000 and typically pay a higher rate than Ginnie Maes
to compensate investors for the extra risk of not being government-insured.
The biggest disadvantages of all three mortgage-backed securities are an uncertain
maturity and irregular monthly payments. Although the mortgages in their portfolios
are issued for 30 years, the average life of a mortgage-backed security is
only 10 to 12 years because homeowners frequently move or refinance. Also,
if investors spend the part of their monthly check that is a return of principal,
instead of reinvesting it, they will have nothing left when the last mortgage
in their Ginnie Mae portfolio is repaid.
Collateralized Mortgage Obligations
Collateralized mortgage obligations (CMOs) are another type of mortgage-backed
security. CMOs were developed to address investors’ concern about receiving
income from other mortgage-backed securities in unpredictable increments. With
CMOs, the portfolio of mortgages is divided into various classes, called tranches,
thus offering investors a choice of estimated maturity dates to match financial
goals. Investors in a particular tranche receive periodic income payments (typically
monthly) that differ from period-to-period and from other tranches. Tranches
with a longer maturity generally pay a higher return to compensate investors
for incurring greater interest rate risk. The principal portion of mortgage
payments corresponding to all tranches goes to investors in a single tranche
until that tranche is retired. Each tranche gets its principal back when all
the tranches before it have been repaid. CMOs are available in $1,000 increments
through brokerage firms and pay a higher yield than comparable mortgage-backed
securities. Two disadvantages are their complexity and the fact that principal
prepayment can still come sooner (or later) than expected. Just as with other
mortgage-backed securities, investors must realize that principal is being
repaid throughout the life of a CMO, not at maturity (like bonds). Investors
who mistakenly think that CMO payments are just interest may inadvertently
spend their principal.
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