No. of Recommendations: 4
First, there are two ways to get GNMAs. One is primary market and the other is secondary.
Primary market, you give your broker an order and buy at auction. A GNMA is usually $25000 face, and you don't pay a premium. That's what you tell your broker.
Secondary market, a large broker, probably one of the wirehouses, has an inventory of pieces of GNMAs. Remember that return of principal starts, although slowly, with the first monthly payment. In a world of rising interest rates, it has been difficult in recent years to get one without paying a premium. But I am entirely bull-headed in this matter, with the result that I haven't bought any GNMAs recently. At the time of the S&L crisis there were a lot of these available from distressed S&Ls. Now they are much less common, but it is worth asking. You might latch onto a piece that is 15 years old, has had a number of prepayments and has just $5000 or so principal left, and maybe at 99.5 or so. Again, don't pay a premium. These are like a bond callable at par any time.

Another twist is the CMO--Collateralized Mortgage Obligation. These come in $1000 denominations. A bank or mortgage company buys a bunch of GNMAs (or Freddie Macs, or Fannie Maes) and repackages them, sells "tranches". Somebody can buy all the initial principal payments while everybody else gets interest only for awhile. When that first owner has received back all his principal, the payments go to the next tranche. The retail customer usually gets no principal until everyone else has been paid off, so you may get a stable interest-only payment for the first several years of the investment, and you probably won't be fully paid off for the 30 years of the original mortgages. The bank that does this repackaging will take about 1/2% of interest for the trouble, plus a little extra float--you get paid on the 25th instead of the 15th. CMOs sell at a discount more commonly than do GNMAs. You have another intermediary in there, but the US government guarantees GNMAs as to timely payment of interest and principal, so there shouldn't be a default problem and I've never heard of one.

A GNMA, or a CMO, does have a final maturity date. Unlike a bond, there is no big lump sum at the end of the investment, and if you've frittered away your principal that comes to you in dribbles over the life of the investment, tough. Actually I've had CMOs pay interest only for several years, then pay off completely over a 3-month period. Of course, this occurs when interest rates are down, home owners can refinance to their advantage, and you can't find another equally good use for your money. Like bonds being called, it will always happen at the most inconvenient time.

For an aging retiree looking for income, the GNMA or the CMO may be a good idea. That person may not need to worry about reinvesting and may consider the return of principal a part of their withdrawal rate.

Best wishes, Chris
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