Government National Mortgage Association (Ginnie Mae)
What it is:
Because the Government National Mortgage Association guarantees mortgage-back securites and effectively assumes the lending risk involved in the mortgage business, lenders are able to resell GNMA backed mortgages easily. The sale of these mortgages provides lenders with funds to make additional mortgage loans. This in turn creates more competition among lenders, which theoretically creates incentive for lenders to have lower interest rates. The GNMA guarantee also gives more assurance to lenders for providing mortgages to low-income homebuyers who would otherwise not qualify for a mortgage.
GNMA securities are the only mortgage-backed securities backed by the full faith and credit of the U.S. government. It is important to note that although these securities are guaranteed by the U.S. government (implying they have no default risk), they are still subject to interest-rate and prepayment risk.
Government National Mortgage Association backed securities generally pay monthly interest and principal to investors. This monthly principal payment means investors earn interest on a decreasing principal amount over time. In addition, if a homeowner pays off his mortgage early, a corresponding portion of any related GNMA mortgage-backed securities are retired early and investors may receive extra payment (prepayment risk).
For more information about the Government National Mortgage Association, go to http://www.ginniemae.com.
How it works (Example):
The Government NationalAssociation is an agency of the United States Department of Housing and Urban Development. It was established by Congress in 1968.
When a GNMA-approved bank makes several mortgages, it may sell the pool of mortgages to a bond dealer. The dealer in turn sells securities backed by the underlying mortgages (hence the name "mortgage-backed securities"). Ginnie Mae guarantees the timely payment of interest and principal on these mortgage-backed securities. It is important to note that the Governmental National Mortgage Association does not buy or sell mortgages nor does it issue the mortgage-backed securities it guarantees.
In general, the GNMA only guarantees mortgage-backed securities that have underlying mortgages insured by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Rural Housing Service (RHS), or the Office of Public and Indian Housing (PIH).
Here's how it works: The original lenders forward monthly payments received from homeowners to an agent, who passes the payments on to the security holders. A portion of the interest payments is retained by the Government National Mortgage Association as a guarantee fee, and another portion is retained by the original lenders as a servicing fee. Say a homeowner defaults on a loan underlying a GNMA security, the GNMA will then make the payments on the mortgage-backed securities until the underlying property is foreclosed.