Beware of Brokerage Firm Mortgages
he National Association of Securities Dealers (NASD) has issued an alert to investors, entitled, "100% Mortgages: The Low Down on No Money Down." In these arrangements, brokerage firm customers can pledge their assets, such as stocks and other securities, for a mortgage instead of making a down payment for that mortgage.
Sounds good? Certainly, brokerage firm websites and advertisements tout the advantages, like avoiding private mortgage insurance and the liquidation of securities. However, be careful! Those websites and advertisements, the NASD finds, "may overlook or consign to the fine print the risks associated with these mortgages."
The alert, found at
www.nasd.com/investor/alerts/alert_100percent_mortgages.htm,
details the important risks to consider. Let's review them. First, customers may be required to deposit more cash or securities, after obtaining the mortgage loan, if the value of the securities pledged falls below the minimum value that the brokerage firms requires. Accordingly, the NASD alert states, "Ask yourself: if I didn't have the cash in the first place for a down payment, where will I find the cash if my securities lose their value?"
The second risk detailed in the NASD alert is that brokerage firms can force the sale of the securities in the customer's account, in what is known as a "collateral call". This happens when the customer does not deposit additional cash or securities.
Third, brokerage firms are not required to notify customers, according to the NASD alert, before the firm decides to sell securities to meet the collateral call. Likewise, firms that contact customers to set a deadline date for deposits of cash or securities may change their mind, and sell anyway, because, for example, the firm viewed market conditions as having changed since the deadline date was communicated. Along the same lines, customers are not entitled to an extension of time to meet a collateral call. And customers are not entitled to choose which securities the firm can sell to meet the collateral call.
Fourth, the NASD alerts customers to the fact that they may risk not only losing their securities that they have pledged, but also losing their home, if they stop making monthly mortgage payments.
In view of these risks, the NASD advises customers to do their homework. First, shop around for a mortgage beyond the brokerage firm - banks, mortgage companies and credit unions all offer mortgages. Then compare costs and negotiate. In this regard, the NASD alert concludes:
Customers probably pay more interest with a 100% asset pledge mortgage than they would had they selected the more common, cash down payment mortgage;
Paying more interest makes sense when the investment returns are greater than the interest to be paid, but there can be no assurance that investment returns will be greater;
The speculative nature of investment returns becomes all the more problematic with adjustable rate 100% asset pledged mortgages, given the possibility that as interest rates rise, so too will the mortgage interest rate rise; and
If the assets pledged include bonds, or other fixed rate instruments, they will decline in value as interest rates rise.
If customers nonetheless decide that the 100% asset pledged mortgage is the best option, the NASD cautions customers to learn how they work, including studying the collateral call policies.
Additionally, the NASD cites ways to minimize the risk of the 100% asset pledged mortgage. First, reduce risk by pledging a diversified portfolio of stocks, bonds and cash instead of a single stock. Second, try not to pledge all available securities, instead retaining some securities in case you later need to meet a collateral call. Third, monitor the price of the pledged securities daily, and proactively make deposits of cash and securities to avoid the prospect of a collateral call.
Overall, be prepared for what may be a rough ride!
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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.
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