Mortgage-backed notes can be tricky

STAYING AHEAD

March 29, 1992|By JANE BRYANT QUINN | JANE BRYANT QUINN,Washington Post Writers Group

New York -- Conservative investors are being bombarded with a pitch for what sounds like the dream buy: a package of triple-A mortgages, with principal and interest guaranteed, yielding an unusually high rate of interest.

I, too, have listened to one of those pitches, from a stockbroker making a cold call. When I asked what's the catch, the broker said there wasn't one. "Your only risk," he joked, "is that you'll get your money back too soon."

These brokers are touting something called a "collateralized mortgage obligation," although those ponderous words may never cross their lips. They often mention only the underlying investments -- usually mortgages backed by the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) or the Government National Mortgage Association (Ginnie Mae).

Current yields on CMOs run from 8 percent to 8.5 percent, which sound pretty sweet to starry-eyed savers who want something richer than certificates of deposit.

But mortgages don't behave like fixed-term bonds or CDs. With bonds you earn interest; on a known date, you get your principal back. But with mortgage-backed securities, you finance hundreds of homeowners who are repaying both interest and principal simultaneously.

You don't know how fast they are going to repay, and that's the catch. If mortgage rates rise, homeowners won't move or refinance as often, so you won't get your money back nearly as fast as you expected. Your cash will be stuck in what will have become a low-rate investment.

By contrast, if mortgage rates fall -- as they did last year -- homeowners will rush to refinance. You'll get your capital back much sooner, forcing you to reinvest the money at a lower interest rate.

The stockbroker who called me made it sound jolly to get my money back ahead of time. But tell that to an investor who bought 14 percent tax-exempts 10 years ago that were recently paid off before maturity. The best available today in compara ble bonds is around 6.25 percent.

Anyone who buys a CMO expects to hold it for a specified time period, but that's usually a pipe dream. Most of the CMOs sold to individuals -- known as "companion" or "support" CMOs -- can't come close to guaranteeing a payback date. You may get

your money much earlier, or later, than planned, depending on what happens to interest rates.

If you're tempted by a CMO, do three things:

* Ask the broker what will happen to the CMO's payback rate and yield if rates rise or fall by one, two and three percentage points. You may be astonished.

* Don't buy support or companion CMOs.

* Consider only the CMOs constructed for institutions, known as PACs (for "planned amortization class"). They're yielding more than half a point less than companion CMOs. But they should repay your money on time, even if rates change by two or three percentage points. PAC-1s are the most stable. Skip the more volatile Pac-2s and 3s.

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