GNMA vs. Short-Term Bonds

As an investor looking for stable, income-producing securities, you may be comparing Ginnie Mae bonds with short-term government or investment-grade corporate bonds. There are distinct tradeoffs between the two, and a final decision is usually a choice between stability or higher interest rates.

GNMA is the acronym for the Government National Mortgage Association, commonly called Ginnie Mae. The agency puts a federal government guarantee on mortgage-backed securities -- MBS -- from pools of FHA and VA home loans. Mortgage securities pay out monthly payments of principal and interest as homeowners of the loans in a mortgage pool make their monthly payments. Ginnie Mae bonds typically pay a higher interest than Treasury securities while providing a federal government guarantee. Ginnie Mae bonds do not have a fixed maturity, but are paid off as homeowners make monthly payment and sell or refinance their homes.

Short-term bonds are fixed-rate debt securities with maturities of three years or less. The category can include short-term Treasury notes and bonds plus investment-grade corporate bonds. Shorter-term bonds have less price fluctuation than longer-term bonds when interest rates change. In times of a normally sloped yield curve, the tradeoff for the short-term price stability is lower interest rates. For example, at the time of publication, the three-year Treasury note was paying just 0.55 percent, while the 10-year note had a yield of 2.77 percent.

In most interest rate conditions, GNMA bonds will pay higher yields than short-term, high-quality bonds. At the time of publication, the yield on GNMA bonds was as high as 2.6 percent compared to less than 1 percent for short-term government and corporate bonds. Ginnie Mae bonds work best in a stable interest rate environment. If rates increase, the term of mortgage securities will stretch out as homeowners hang on to their current loans. Falling rates will result in moderate price increase of GNMA securities. However, Ginnie Mae investors may see their principal return faster as homeowners refinance to lower rates.

Short-term bonds provide a high level of principal stability. Rising interest rates cause bond price to fall and short-term bonds will decline less than longer-term bonds. A short-term bond will mature soon and the proceeds can be reinvested at a higher rate if rates are increasing. Short-term bonds are a better choice than Ginnie Mae bonds when rates are expected to increase or if stability of principal is a primary investment goal. Short-term bond principal amounts are returned at one time when a bond matures. This feature makes reinvestment easier than with GNMA bonds, where principal is returned in small amounts each month.