News Release

NASD Alerts Firms About Liquified Home Equity Concerns

Washington, D.C. — Concerned about the increasing number of investors who are turning home equity into cash to make investments, NASD today reminded regulated firms of their obligation to perform a careful suitability analysis before recommending such a strategy to an investor.

“Many homeowners have become wealthier – at least on paper – because of escalating home values. And more of them than ever before are tapping into their increased home equity to purchase securities,” said NASD Vice Chairman Mary L. Schapiro. “But turning equity into cash to make financial investments isn’t an appropriate strategy for many investors. That strategy poses significant and unique risks, and failure to understand those risks could cost them their biggest asset -- their home.”

NASD spelled out its concerns and its recommendations to regulated firms in Notice to Members 04-89: Liquefied Home Equity. In March, NASD issued an Investor Alert on the subject, Betting the Ranch: Risking Your Home to Buy Securities. In May, NASD issued a related Investor Alert on the risks associated with pledging securities in lieu of a mortgage down payment,100% Mortgages: The Low Down on No Money Down.

The concerns outlined in the Notice to Members issued today include:

  • The increasing use of home equity for investments. In addition to its own observations, NASD cites a Federal Reserve Board study that found that during the most recent period it reviewed – 2001 through the first half of 2002 – 11 percent of the total funds from  mortgage refinancings were used for stock market and other financial investments. That’s up from less than two percent during the previous period studied, 1998 through the first half of 1999. The average amount of cashed-out home equity individuals used for investments also increased substantially – from “relatively small amounts” in the 1998-1999 period to more than $24,000 in 2001-2002. The average amount used for investments was greater than nearly all other categories, including home improvement.
  • An investor may lose his or her home if the return on investments is not sufficient to cover the new mortgage or line of credit obligations. Or, if the value of an investment decreases, the investor may need to sell his or her investments to protect his or her home and limit further losses.
  • Investors may fail to recognize potential conflicts of interest, such as a broker’s interest in generating commissions or fees on investments from the cash proceeds of a refinancing or home equity line of credit – or the firm’s interest in generating compensation for itself or an affiliate for originating and/or servicing the new mortgage or line of credit.
  • Cashing out home equity may undermine the asset diversification benefit of home

The Notice to Members issued today recommends that, in addition to the factors typically considered as part of a suitability analysis, regulated firms also consider the amount of equity the investor has in his or her home; the level of equity being liquefied for investments; how the investor will meet his or her increased mortgage obligations; whether the new mortgage or home equity loan is at a fixed or variable rate; the investor’s risk tolerance with respect to the funds being invested; the investor’s overall debt burden, and the sustainability of the value of the investor’s home.

NASD’s Notice to Members also includes “best principles” for disclosing relevant risks and conflicts, including: the potential loss of one’s home; the fact that unlike other potential lenders, the recommending firm has an interest in having the proceeds of the loan used for investments that may generate commissions, mark-ups or fees for the firm; the recommending firm or its affiliate may earn fees in connection with originating and/or servicing the loan; the impact of liquefied home equity on the ability to refinance a home mortgage, and the possibility that a change in home value could result in negative equity in the home.

The Notice to Members also recommends that firms consider whether to establish general standards for when a recommendation to invest home equity proceeds should be prohibited – for instance, when an investor wishes to use home equity for particularly risky investments, or wants to withdraw home equity above a specific threshold.

Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck.  NASD makes BrokerCheck available at no charge to the public.  In 2003, members of the public used this service to conduct more than 2.8 million searches for existing brokers or firms and requested almost 180,000 reports in cases where disclosable information existed on a broker or firm.  Investors can link directly to BrokerCheck at www‌.nasdbrokercheck.‌com. Investors can also access this service by calling 1-800-289-9999.

NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services.  NASD touches virtually every aspect of the securities business - from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and member firms.  For more information, please visit our Web Site at www‌.nasd.‌com.