Ginnie Mae No Haven From the Tax Collector

QUESTION: I am thinking about investing in Ginnie Maes. But I am getting conflicting opinions about whether the interest they earn is exempt from state taxes. Can you help? E. N.

ANSWER: States do indeed tax the income that investors earn from Ginnie Mae certificates. And any that didn’t previously tax them will certainly start doing so after hearing about a recent Supreme Court ruling confirming states’ rights to tax such investments.

Your confusion is perfectly understandable, however. There is a federal law that exempts from state taxation “all stocks, bonds, Treasury notes and other obligations of the United States government.” And since Ginnie Maes are mortgage-backed securities issued by a corporation owned by the federal government--the Government National Mortgage Assn. (GNMA)--it seemed logical to many tax and investment experts that Ginnie Maes qualified for the exemption.

One who took a chance on that interpretation--and lost--was Rockford Insurance of Illinois. The company sued the state of Illinois after being charged state tax on the value of the Ginnie Maes in Rockford’s investment portfolio. It lost in the Illinois Supreme Court and in the U.S. Supreme Court on grounds that these investments are “fundamentally different” from such U.S. government obligations as Treasury bills, which are backed by the full faith and credit of the U.S. government.

The GNMA, as a government-owned and -financed corporation, is administered by the Department of Housing and Urban Development. That is different, the court ruled, than if it were a government agency, such as the Department of Treasury.

Ginnie Mae securities are packages of mortgages that have been financed by the GNMA. Often, they are mortgages on such high-risk areas as inner-city public housing or commercial development projects--projects that would have difficulty getting financing if not for the federal government’s intervention.

GNMA has been in business since 1970. But it became especially popular in 1982, when it came to the rescue of the beleaguered savings and loan industry. By buying old, expensive mortgages from the S&Ls;, bundling them into securities and reselling them, GNMA helped S&Ls; get the expensive mortgages off their books and thus made available more money for new home mortgages.

Ginnie Maes are called pass-through certificates because they “pass through” a homeowner’s mortgage payments--minus collection costs and fees--to the Ginnie Mae investor. So, by investing in Ginnie Maes, you are in effect lending money for people to get a mortgage on their house.

The GNMA, in turn, guarantees that the investors will get a portion of this mortgage principal and interest each month--even if the individual homeowner payments aren’t made on time.

One word of caution, though: What GNMA doesn’t guarantee is a fixed monthly payment. The amount a Ginnie Mae investor receives each month will fluctuate with interest rates. For each percentage point change in interest rates, expect the monthly payment from your Ginnie Mae to move about 6% in the other direction. Thus, the investment may be fully exhausted before the cited maturity date.

Ginnie Mae pass-through certificates can’t be had for less than $25,000. But mutual funds are now investing in Ginnie Maes, too, and a small investor can buy into those for as little as $1,000.