Pledging Assets For a Down Payment
By JAY ROMANO
Published: November 21, 2004
IT is said that the best way to get a loan is to convince the lender that you don't need it. So it makes sense that some investment companies offer 100 percent mortgages to buyers who have enough money invested to serve as collateral for what would otherwise be a down payment.
While such loans, called pledged asset mortgages, have been around for a while, mortgage experts say that optimistic hopes for the stock market may increase their popularity. Those same experts say, however, that while pledged asset mortgages may be good for some, they carry risks and are not suitable for all.
Richard Musci, chief lending products officer for Charles Schwab Bank, said in a press release introducing the company's pledged asset mortgage that his company was responding to clients who want to buy a home "without having to liquidate assets and alter their investment strategy."
Schwab's program is similar to pledged asset programs offered by other lenders. A borrower who has liquid investments like stocks, bonds and certificates of deposit can pledge those investments as collateral for the cash down payment typically required for a mortgage. With Schwab, the borrower must have liquid assets of at least $250,000 and can pledge no more than 60 percent of their total assets as collateral.
Other lenders have different requirements. Under Fannie Mae's pledged asset program, if a borrower - or a family member of a borrower - pledges a certificate of deposit for at least 5 percent of the sale price, the borrower can get 100 percent financing on a single-family residence.
Anthony B. Sanders, professor of finance at Ohio State University, said that with a regular mortgage, a larger down payment generally means a better interest rate. In addition, a down payment of less than 20 percent usually requires the purchase of private mortgage insurance to make the lender more comfortable about making the loan.
But buyers whose assets are tied up in investments may not want to liquidate those investments to come up with a cash down payment. For one, capital gains taxes may have to be paid if the investments have appreciated. In addition, the buyer may believe that the investments will produce a greater rate of return than the home will. So instead of cashing in the investments, a borrower can use them as collateral for what would otherwise be a down payment.
Holden Lewis, a financial writer for Bankrate.com, which specializes in finance and investments, offered an example. A person buying a $500,000 home might need a down payment of 30 percent, or $150,000, to get the best rate and also avoid paying for private mortgage insurance. But if that buyer had a significant amount of investments, she could pledge some as collateral for the $150,000 and get a mortgage for the entire $500,000. Since investment values fluctuate, the pledged amount includes a cushion. A lender might require pledged assets of 130 percent of the amount required for the down payment - in this case $195,000 in assets.
Gail Liberman, a co-author of "Rags to Retirement" (Alpha, 2003), a book about investing, said there are risks with such mortgages. First, she said, the collateral is typically placed in an account maintained by the lender and cannot be sold without being replaced. Also, if the value declines, additional assets must replace the lost collateral. Most significantly, she said, if the value of the pledged assets cannot be maintained, the lender can foreclose.
"It's a double whammy," she said. "You run the risk of losing not only your stock portfolio but also your most precious asset, your home."
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