Ihave received several questions lately that seriously worry me about the advice homeowners are getting from so-called financial experts.
Homeowners have been asking whether I think it’s a good idea to refinance, or to obtain a home equity loan or line of credit (secured by their homes), for the specific purpose of investing in securities (stocks and bonds).
The short answer is: Don’t even think about it. Make no mistake about this. When you use mortgage money to buy securities, you aren’t investing, you’re gambling.
It’s not like I don’t understand the logic (as flawed as it is) behind the advice to mortgage your home to invest.
The stock market is doing better, and at the same time many people have seen the value of their homes go through the roof.
So people with little to no savings are being advised to tap into their home’s equity to find the money to play the market. The theory is that the investment will return more than enough to make payments on a new mortgage or equity loan or line of credit – plus generate additional income.
This plan may work only if everything goes right. But when does everything always go right when you’re investing?
NASD (formerly the National Association of Securities Dealers) felt this issue was so serious that the organization issued an alert warning investors that if they must rely on investment returns to make their mortgage payments, they could end up defaulting on their home loans.
“We are really concerned that this type of recommendation is inappropriate for almost everyone,” said John Gannon, vice president of investor education for NASD.
In fact, such a recommendation to an investor could result in a sanction from NASD. This year NASD brought enforcement cases against three brokers for advising clients to mortgage their houses to invest.
Here’s what can happen when you gamble with your home, NASD says:
* Unlike investing with savings, when you invest with money pulled out of your home, you stand to lose more than your principal if the investment goes sour. You could lose your principal residence. Even if you don’t lose your house, you are jeopardizing the equity you’ve built up.
* While this strategy increases your buying power, it also increases your exposure to market risk.
* Using your home equity might make you too bold. You might be tempted to invest in higher-risk investments than you would normally select in an effort not only to match the rate of your home loan, but in the hopes of surpassing it.
* Here’s the final flaw in this investment strategy: You’re investing with borrowed money. And while current fixed mortgage rates are low by historical standards, if you get a mortgage with a variable interest rate, it can rise if interest rates increase. “God help anybody who gets a variable rate mortgage and starts investing,” Gannon said. “Not only is your investment moving up or down but so is your mortgage.”
Still not convinced? Here’s a real-life worst case scenario. This story comes from one of the cases in which NASD sanctioned a broker.
According to a NASD disciplinary file, a couple who together made $60,000 a year was advised to mortgage a home they owned outright in Vail, Colo. The home was appraised at $800,000. A broker persuaded the couple to take out a mortgage and use the proceeds to purchase a variable annuity, which they were told could grow to $1.3 million. They took out a mortgage for $400,000 at 8.25 percent. The monthly payments of principal, interest and escrow totaled just over $3,200.
To have enough to pay the mortgage, the annuity had to consistently generate a net yield, after all expenses, of no less than 8.25 percent.
Well, can you guess what happened?
Instead of gaining value, the annuity lost money from the start. Two years after buying the annuity, the couple’s investment was reduced to $187,000.
“Investors have to ask the question: ‘How will I pay for my mortgage loan if my investments decline?’” said James J. Eccleston, an attorney who heads the securities practice at the Chicago law firm of Shaheen, Novoselsky, Staat, Filipowski &Eccleston. “In a market when returns are flat or even slightly up, but nowhere near the 12 percent or 10 percent market average, it’s tough to meet that mortgage payment each and every month. Most likely investors will have to eat into their principal.”
It’s true that your home can be a great investment, but don’t take that notion too far. If a broker or financial adviser recommends that you pull money out of your home to invest, you need to say: “Don’t let the door hit you where the good Lord split you.”
Washington Post Writers Group
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