Betting the Ranch: Risking Your Home to Buy Securities
When the stock market is rising and mortgage interest rates are low, some investors may be tempted to take out new mortgages, refinance, or obtain lines of credit secured by their homes for the specific purpose of investing in securities. The hope is that the investment will not only pay the mortgage, but also generate additional income. Unfortunately, it doesn't always work out that way.
We are issuing this alert because we are 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. In short, investors who bet the ranch could lose it.
This alert outlines the risks involved in playing the market with the equity in your home and offers advice to consider before making such an investment decision.
Your Risk is Compounded
There is risk to principal when you invest in virtually any security. Cashing out your home equity to buy securities compounds your risk for the following reasons:
- When you buy securities with mortgage money, you are investing with borrowed funds. While this increases your buying power, it also increases your exposure to market risk, similar to buying securities on margin. The difference is your mortgage loan is likely to be greater than any amount a securities firm would loan you on margin. Investing borrowed mortgage money amounts to a huge bet that the investment will increase.
- Unlike investing with savings, when you invest with mortgage money, you stand to lose more than your principal if the investment sours. You can lose the collateral supporting the loan—namely your house. Even if you don't lose your house, you could lose the equity in your home that may have built up over a considerable period of time.
- You may put your money in higher risk investments than you might normally select, in an effort not only to match the rate of your home loan but in the hopes of surpassing this rate. Furthermore, with so much at stake, if a given investment does poorly, you may feel compelled to move your investment into even more risky investments to make up the difference, further jeopardizing your home, credit standing, and overall financial health.
Worst Case Scenarios Can Happen
We are aware of instances in which investors have had difficulties paying their mortgages as a result of declines in their mortgage-financed investments. Here's how this can happen:
A retired couple's house is paid off, but they have very little extra money to meet their everyday living expenses. They decide to take out a new mortgage of $250,000 at 6 percent, seeking to invest this mortgage money in the hope of making more than 6 percent. They lock into a mortgage requiring monthly payments of $1,663. On the advice of their broker, they invest their mortgage money in a mutual fund that has earned an average of 12 percent over the past five years. But instead of gaining value, the couple's investment loses money from the start and continues to decline. After one year, their investment is worth $200,000. Since they were depending on this investment to generate $1,663 per month to pay the loan and have no other assets to liquidate to make up the difference, they are faced with a tough choice: Sell off part of their now depleted original investment to pay the mortgage payments and hope that the investment turns around, or sell their house and hope that the selling price is enough to pay off the loan and pay for real estate commissions. Either way, they run the risk of losing money—and their home.
How to Avoid Losing Your Home
If your broker recommends this strategy, it comes down to one very simple question. Before taking out a mortgage or refinancing to invest in securities, ask yourself: How will I pay for my mortgage or loan if my investments decline? Do you have a secure salary or reserve funds to make mortgage payments if your investments lose value?
If the answer is no—just say no to betting the ranch to invest in securities.
Where to Turn for Help
If you already have a problem with a mortgage-financed investment recommendation that your firm did not resolve to your satisfaction, you can file a complaint online at FINRA's Investor Complaint Center.
To learn more about the risks of investing with borrowed funds, read Investing with Borrowed Funds: No "Margin" for Error.
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