GNMA funds are mutual funds which have mortgage-backed securities issued by the Government National Mortgage Association, or Ginnie Mae. The U.S. government ensures the payment of interest and principal from Ginnie Mae bonds. GNMA funds are a choice for investors looking to get a higher but safe rate of interest, but these funds still have a few dangers.
Interest Rate Risk
The Ginnie Mae bonds held with GNMA funds are marketable securities, and their worth is dependent on current market interest rates for similar securities. Bond costs, such as GNMA bonds, vary inversely to changes in rates of interest. If prices rise, the market cost of the Ginnie Mae bonds in a portfolio will decline. The fund reflects these cost declines with a decreasing share price. In a rising rate environment, the share value of a GNMA fund can diminish faster than the interest paid makes up for the decline. This result is particularly detrimental to investors that are taking their fund dividends in cash and see their principal value decreasing.
Prepayment Risk
A GNMA mortgage protection is compensated from a pool of mortgages with the same interest rate and maturity. Ginnie Maes are securities. As the homeowners at the pool make their mortgage payments, the Ginnie Mae bond holders receive monthly payments of principal and interest. When mortgage interest rates decline, the homeowners can decide to refinance their mortgages, and the GNMA fund owning the bonds will start to receive larger principal payments from the bonds it holds. Bonds with fixed maturities will see their market values increase when prices drop. GNMA funds will see their principal come in faster, which will have to be reinvested at lower rates of interest. Investors at a GNMA fund will probably find their dividend rate decline at a faster speed than with a fund which owns fixed-maturity bonds.
Duration Risk
The open-ended length of GNMA securities has exactly the contrary effect if prices rise. Homeowners whose mortgages make up the Ginnie Mae pools will be less likely to refinance their low-rate mortgages, and the expected length of their GNMA bonds will lengthen. This usually means a Ginnie Mae fund will receive principal payments in a slower rate. Less principal repayments means less money which can be reinvested in the higher current interest prices. In a rising rate environment, GNMA fund holders will see their share values drop, and the capital will probably require longer to have the ability to pay the higher prices of their current bond market.
