Investing in Mortgage-Backed Securities

Mortgage-backed securities represent an ownership interest in mortgage loans made by financial institutions such as savings and loans, commercial banks or mortgage companies, to finance the purchase of a home or other real estate. Mortgage-backed securities are created by pooling these loans for sale to investors. As the homeowners pay off the underlying mortgage loans, the investors receive payments of interest and principal.

Mortgage-backed securities typically feature some of the highest yields of any government or agency security, often exceeding the yields of most investment grade corporate issues. A direct result of higher yields, mortgage-backed securities can provide investors with high interest payments compared to other fixed income securities. Investments in mortgage-backed securities are subject to all applicable federal, state and local taxes.

Risks of investing in mortgage-backed securities include prepayment and extension risk. Prepayment risk is the risk that homeowners will pay off more than their required monthly mortgage payments which may result in the shortening of the average life of the bond and by returning principal prematurely to the bondholder, potentially at a time when interest rates are low. Conversely, extension risk is the risk that homeowners will make only the required monthly payment, which may result in a security that is lengthier in term than originally anticipated.

Types of Mortgage-Backed Securities

Pass-throughs. Also known as participation certificates (PCs), pass-throughs represent a direct ownership interest in a pool of mortgage loans. The issuer of the pass-through collects monthly payments from homeowner and then passes on a proportionate share of the principal and interest to the investors.

Issuers of Mortgage-Backed Securities

Government National Mortgage Association (GNMA or Ginnie Mae). GNMA is a government-owned corporation within the Department of Housing and Urban Development and securities issued by GNMA are backed by the full faith and credit of the United States government. The purpose of GNMA is to ensure that mortgage funds are available throughout the United States. GNMA securities are available in a variety of maturities, with a minimum denomination for new issue securities of $25,000 with additional increments of $1,000.

Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) and Federal National Mortgage Association (FNMA or Fannie Mae). Both the FHLMC and FNMA are publicly-owned corporations that are government-sponsored enterprises, but are not explicitly guaranteed by the U.S. government. The purpose of the FHLMC is to increase the availability of mortgage credit for residential financing, while the purpose of the FNMA is to maintain an active secondary market for mortgages. Both organizations issue mortgage-backed securities and standard corporate coupon bonds. Investments in both types of securities are available in $1,000 increments.

Your Ziegler financial advisor can help you determine if mortgage-backed securities are appropriate investments for your portfolio. Contact your advisor or our Client Service Center at 888.816.4466.

Fixed income securities are subject to market risk and interest rate risk. If sold in the secondary market prior to maturity, investors may experience a gain or loss depending on interest rates, market conditions and the credit quality of the issuer. B. C. Ziegler and Company does not provide tax or legal advice. Please consult with your tax advisor regarding the suitability of these investments in your portfolio.

Any government agency backing applies only to the face value of the CMO and not to any premium paid.  A CMO's yield and average life will fluctuate depending on the actual rate at which mortgage holders prepay the mortgages underlying the CMO and changes in current interest rates.