The government will tell you that we are coming out of recession and economic recovery is right around the corner. Since the mortgage meltdown could be considered the root cause of the economic downturn, it’s helpful to look at the current housing market to get a sense of whether the recovery is hitting close to home. As prices have continued to drop in cities across the nation, the number of home sales has been increasing in many areas. Especially profound was the dramatic percentage increase year-over-year between Q3 and Q4 in total properties sold. Our latest map may not be able to tell you when to buy and when to sell but it will give you some strong data with which to make an informed decision.

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Have I got an investment opportunity for you: mortgage-backed securities. You invest in a pool of mortgages, and—hey, wait, where are you going?

I’m not talking about the toxic securities that almost destroyed the economy in 2008. I’m talking about GNMA bonds, better known as Ginnie Maes. Unlike other MBSes, the principal and interest on Ginnie Maes are explicitly backed by the full faith and credit of the US government. And investors are flocking to them.

This doesn’t mean you can’t lose money on Ginnie Maes. You can, and I’ll explain how in a minute. But first I’ll walk you through how they work and why you might want to have some in your portfolio.

What is Ginnie Mae?

Sounds like the sister to Fannie Mae and Freddie Mac, doesn’t she? In fact, the Government National Mortgage Association is quite different. First, she (okay, it) has always been part of the federal government. Second, it doesn’t buy mortgages or issue MBSes.
Instead, Ginnie Mae is like the FDIC. A mortgage lender takes a bunch of FHA and VA loans and packages them into a security—a bond. In exchange for a cut of the mortgage, Ginnie
Mae then insures the bondholder against default.

This is actually an oversimplification: the FHA and VA insure against default; Ginnie Mae is in charge of keeping the payments coming to the bondholders even when the mortgage is delinquent. In other words, if a mortgage in the bond gets behind on payments, the person who bought the bond will continue to receive principal and interest payments, courtesy of Uncle Sam, right on time.

Sounds awesome, right? Except you, Jane Sixpack, can’t actually buy a GNMA bond, because they cost about a million dollars. But you can buy into a GNMA mutual fund.
Fun with GNMA funds

All of the major brokerage houses offer GNMA funds. Here are a few to get you started:

• Fidelity GNMA Fund
• Vanguard GNMA fund
• T. Rowe Price GNMA Fund

If a fund has “GNMA” in its name, it’s required by the SEC to invest at least 80 percent of its assets directly in Ginnie Mae securities. (The other 20 percent are invested in other government securities or in Fannie and Freddie securities.)

Historically—and remember that historical performance is just yesterday’s news—GNMA funds have returned about six percent annually before inflation, and their volatility is low compared to other bond funds with comparable yields. GNMA funds offered relatively steady returns right through the housing bust.

Bonds with no default risk? What could possibly go wrong?

A couple of things. First, like all bonds, GNMAs are subject to interest rate risk. If interest rates rise sharply—something bound to happen in the future, since they can’t go any lower than they are now—bonds lose value. GNMA funds have occasionally lost principal in a year like that, although never a lot of principal. Some funds lost on the order of six percent in the early 80s.

You can also get into trouble with GNMAs when interest rates fall. That’s because there are mortgages in them thar bonds, and when rates go down, homeowners refinance. If every mortgage in your bond gets paid off through refinancing, you just made much less on the bond than you expected, plus the fund manager will now have to buy new bonds at lower interest rates. This is called prepayment or call risk.

“It’s what on the street they call convexity,” says Louis Gasper, former executive vice president of Ginnie Mae and now an associate professor in the graduate school of management at University of Dallas. “You tend to get much greater movement in price on GNMAs when interest yields do change.”

Prepayment risk hasn’t been much of an issue in the current low-interest-rate environment, however, because credit has been scarce and because few homeowners want to refinance or prepay while their home value is depressed.

Finally, GNMA funds are actively managed, so you’re counting on the competence of fund manager.

Safe as houses?

So, should you put some money into a GNMA fund?

It’s not a place for high rollers. If “Ginnie Mae” sounds like your grandma’s name, it’s because it would be a good place for her to sock some of her retirement savings. It’s also a good place to find a six percent return when the stock market is going nuts.

In exchange for this fairly steady performance, you give up the chance to earn any returns that could be described as “rollicking.” Indeed, GNMAs tend to underperform during a bullish bond market.

Oh, and if you buy a house today with an FHA or VA loan, as more homebuyers than ever are doing, your loan will end up in a GNMA bond. If you then invest some of your retirement savings in GNMAs, well, you could end up sending your mortgage payments to yourself. Which is not a bad thing. But it is funny.

For more on GNMAs, see this overview from Fidelity.
Disclosure: I don’t own any GNMAs except as a tiny part of a retirement lifecycle fund.

Matthew Amster-Burton, author of the book Hungry Monkey, writes on food and finance from his home in Seattle.

Budget planning is something that we care about here at Mint. Learn more with great budget planning tips in our blog article index.

What are the benefits of using fixed-rate mortgage in purchasing or refinancing your home? If you are in an adjustable-rate loan, should you consider refinancing and getting out of it while you still can or buckling down and budgeting your money before interest rates get too high and home values drop?

There’s no simple answer to that question, since so much depends on your specific home, loan, and personal financial situation. But you’ll also find that, depending on your state or county, a different type of mortgage is appropriate for you. Sound confusing? It shouldn’t be: simply put, areas with home values that are increasing (and where interest rates are low) often choose to have adjustable-rate mortgages on their properties. On the flip side, many U.S. homeowners find a fixed-rate loan to be safer and less dependent on market conditions. It also provides people with security and a sense of self-confidence in their ability to meet financial obligations.

While an adjustable-rate mortgage (ARM) might work for you if you fully understand the terms and conditions, you have to work on budgeting your money. By their nature, in an ARM, interest rate will increase or decrease – and you should be prepared. In recent years, the interest rate has risen steadily, causing many homeowners with adjustable-rate loans to see rising costs in month-to-month payments.

An ARM is a gamble – you’re gambling that the interest rate will decrease and home values will increase. If you happen to be wrong, you could face an insurmountable monthly payment and a decreased home value.

On the other hand, you could look into a fixed-interest mortgage. As you look into the best home loan option, here are three advantages of fixed-rate mortgages to consider:

• Decreased risk. Your month-to-month mortgage payments are fixed. Even if the current interest rate increases, yours will stay put, which is an essential point of security for many homeowners. This is one reason why fixed-rate mortgages are popular, particularly with first-time home buyers.
• Secure long-term planning. Since your monthly mortgage payments won’t change, you have the security of planning out your payments throughout the life of the loan. You can carefully plan for things like property taxes and insurance, and it also allows you to be financially responsible in planning out your family’s future.
• Budgeting your money. For the most part, we can’t predict the ebb and flow of interest rates. Inflation may cause interest rates to rise, which would cause you a great deal of trouble with an adjustable-rate loan. With your fixed-rate loan, though, you can ride out the storm at ease. Your mortgage rates will stay the same, even if your taxes and insurance costs rise.

Fixed-rate mortgages have been a secure way for home owners to purchase homes for decades. Over the years, loan-to-value ratios have fluctuated and interest rates have moved up and down, but the security that a fixed-rate mortgage offers has never lost its appeal to homeowners throughout the U.S.

Fixed-rate mortgages may have a timeline between 10-50 years, but a 30 year amortization period is most common. People often choose a 30 year loan, because it often gives you a reasonable monthly payment to shell out. Rising home costs, though, have increased the number of 40- and 50-year loans being accepted. While that may be a good move to make the month-to-month mortgage payments reasonable, it does increase the amount of interest on the loan by stretching those interest payments over a much longer period of time – with a 50-year loan, almost twice the amount!

Understanding closing costs. Also known as settlement costs, closing costs are fees and expenses over and above the price of the property, incurred by the buyer and/or the seller in the property ownership transfer.

During the early years of a fixed-interest mortgage loan, much of your monthly payment goes toward eliminating the interest. As the loan progresses, though, that will change: slowly but surely, most of your payments will go towards that principal, such that by the end of your loan almost all of your money will go towards principal payments.

This type of fixed-interest payment plan means that it will be harder to sell your home during the first few years. Very little of the principal will have been paid off, so the loan will still be high. If the house did not appreciate in value, the financial situation gets difficult. However, if home values are increasing, then it will be a significantly smaller problem that so much of the principal has yet to be paid.

As the homeowner, you have some choices with this, too: making a larger monthly payment and directing more of it towards budgeting your money will decrease your principal loan balance faster, and decrease the amount of interest that’s left over. Say, for example, that you paid half of your monthly mortgage every two weeks; that would pay off your mortgage about 5.25 years faster than scheduled. Paying one extra payment per year would reduce the amortization period by 5.25 years, as well. Options like these aren’t requirements, but they do shorten your payment periods significantly.

Another factor to a mortgage loan is the “point” system. Points will decrease your interest rate if you pay an additional fee – about 1% of your loan for each point. Depending on your circumstances, it could be a good idea to invest in points, but you’ll want to calculate your overall savings before you start buying them. To recover the cost of those points, you’ll want to figure out your monthly savings with the lower interest rate versus the rate without points. Divide that number into your points to arrive at the number of months it will take you to break even. Beyond that, all of your savings are yours to keep.

To give an example of that, if you decide to pay for 2 points on a $300,000 loan (for an interest rate of 5% rather than 7%), your payment will be $1610.46. However, stuck with the 7% interest rate, you’re left with the payment of $1995.91. The difference between the two payments is $385.45.

Two points will cost $4,000. To recoup that investment, $4,000 divided by $385.45 equals almost 10.4 months. By your 11th month, not even one year of payment, you will begin to profit from paying those points with a personal budget planner.

Hopefully it’s become clear now that your choices involved in a fixed-interest rate mortgage loan can be extremely beneficial to your personal financial situation. There are many ways that you can decrease the term of the loan or the overall interest rates of the loan. With smart financial planning, you can be through that loan and into financial freedom quickly.

Further Reading on the Topic:

Personal Budget Planner

Budgeting Your Money

Home Budget