Investing in collateralized mortgage obligations makes safe, but sound sense
You may be an "investor" in the Wall Street sense of the word, but your best investment is in your own backyard. By making your monthly mortgage payments, you’re building equity in your home. And while you may already be familiar with the advantages of investing in your own house, there are other ways you can invest in a mortgage that’s not your own.
One of the myriad investment vehicles available on the market today, collateralized mortgage obligations, or CMOs, belong to a family of investments known as mortgage-backed securities. These derive their value from mortgage loans, like the one you may have on your home. Mortgage-backed securities represent an ownership interest in mortgage loans, and they are created when many such mortgages are grouped together as mortgage pools and sold to investors.
When you buy a CMO you essentially purchase a "share" of the underlying pool of mortgages. Principal and interest payments pass through to you and other CMO holders as individual homeowners make payments on their home loans.
Many CMOs are issued and/or backed by government agencies and government-sponsored enterprises, or GSEs. These include the Government National Mortgage Association (GNMA or Ginnie Mae), Fannie Mae and the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac).
CMOs that are issued or have their collateral guaranteed by U.S. government agencies or GSEs represent the most secure CMO structures, but even private-label issuers often enjoy strong credit ratings. For example, Ginnie Mae is a government agency, so its CMOs are backed by the full faith and credit of the U.S. government (for the face value, but not any premiums paid). Fannie Mae and Freddie Mac, on the other hand, are GSEs created by Congress to help support affordable housing. While Fannie and Freddie obligations are not guaranteed by the government, their issues are regarded as high quality because of their role in supporting U.S. housing policy.
Homeowners often take advantage of clauses in their mortgages allowing them to pay off (or "prepay") their debt earlier than the loan’s full term through refinancing, relocation and new home purchases. Because of this, CMO investors will likely receive their principal earlier or later than originally projected. 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.
For many conservative income investors, CMOs offer an alternative to more traditional investments. But they are also complex, so you should do your homework before you decide to buy. It would probably be a good idea to speak with a financial consultant as well, to help you make a sound investment decision. But if you’re looking for other investment options, collateralized mortgage obligations may provide the opportunity you’re looking for.
Darreld Hutchins of A.G. Edwards & Sons Inc. in Vancouver is the assistant branch manager and carries the designations of Accredited Asset Management Specialist (AAMS) and Retirement Planning Consultant (RPC). He can be reached at 360-693-1225 if you have any further questions. Member SIPC.