Don't "Bet the Ranch" By Investing With Mortgage Proceeds

Don't "Bet the Ranch" By Investing With Mortgage Proceeds

Download Acrobat Reader

ortgages should not be used to pay for investments. The National Association of Securities Dealers (NASD) has issued that caution to investors and has penalized three stockbrokers who had failed to recognize the imprudence of the strategy.

The mortgaged investment strategy has been prompted by the rising stock market, record low interest rates and large gains in home value. The mortgages typically have been new mortgages, refinanced mortgages and lines of credit secured by homes.

While the hope is that the investment return outpaces the mortgage interest, the NASD sees no wisdom in the strategy. In an Investor Alert (found at www.nasd.com/investor//alerts/alert_betting_ranch.htm) , the NASD states that it is "concerned that investors who must rely on investment returns to make their mortgage payments could end up defaulting on their home loans if their investments decline and they are unable to meet their monthly mortgage payments."

For readers who doubt that any stockbroker would recommend such an unwise strategy, consider that the NASD has announced charges against three stockbrokers for recommending just such a strategy. The NASD suspended one stockbroker for six months for recommending that customers purchase $80,000 in mutual funds when the only funds that they had available were from mortgaging their homes. The NASD suspended another stockbroker for six months and ordered restitution because he had recommended that a retired couple buy a variable annuity even though their only source of funds was their mortgage. A third broker, who chose not to settle the charges, allegedly did the same thing, indeed placing his customers in jeopardy should the variable annuity not perform at the "very optimistic levels needed to avoid depletion of principal."

The NASD especially is serious about this abuse. According to Mary Schapiro, NASD's Vice Chairperson, this strategy "raises all kinds of regulatory red flags", and the NASD "always will ask whether it is appropriate."

Why the grave concern? In its Investor Alert, the NASD identifies three factors that make the mortgaged investment strategy dangerous. First, the mortgaged investment strategy is worse than a brokerage firm margin loan to the customer. That is because the mortgage loan likely will be greater than any margin loan a brokerage firm would be willing to offer.

Second, the mortgaged investment strategy is worse than investing with life savings because investors stand to lose more than their principal if the investments go sour. Investors also can lose their home.

Third, to earn a return on investments purchased through a mortgage, the return has to be great enough to pay the mortgage interest. The NASD is concerned that the need for a certain level of return may cause investors to take excessive risks in their investments.

What should investors do? The NASD advises to ask one question, "How will I pay for my mortgage or loan if my investments decline?" If investors do not have a secure salary or reserve funds to make mortgage payments, stay clear of the mortgaged investment strategy. Don't "bet the ranch!"

_______________________________________________________________________
James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.