100 Percent Mortgages: The Low Down on No Money Down
Don't have the cash for the down payment on your dream house? At some brokerage firms that offer up to 100 percent loan-to-value ratio mortgages or pledged-asset mortgages, that's not a problem.* In lieu of a down payment for a mortgage, customers can pledge their stocks, bonds, mutual funds, and other securities. While brokerage firm websites and brochures often tout the advantages of 100 percent mortgages, such as allowing investors to avoid private mortgage insurance or liquidating their securities, they may overlook or consign to the fine print the risks associated with these mortgages.
We are issuing this Alert because 100 percent mortgages are not suitable for everyone. We are concerned that many investors are not aware of the risks of 100 percent mortgages and do not understand that the securities they pledge in lieu of a down payment may be liquidated if the value of the securities drops below a certain level or they default on their mortgage.
Before you decide to apply for a 100 percent mortgage, make sure you understand the following risks:
- Even after you obtain your mortgage loan, you may be required to deposit more cash or securities if the value of the securities you pledged falls below the minimum required by your firm.
- Your firm can force the sale of securities in your account to meet a collateral call.
- Your firm can sell your securities to meet a collateral call without contacting you.
- You are not entitled to choose which securities in your account are sold to meet a collateral call.
- You are not entitled to an extension of time to meet a collateral call.
- If you default (stop making your monthly payments) on your mortgage, you could lose both your house and the securities you pledge.
This Alert will explain these risks and provide you with some basic facts about 100 percent mortgages.
How 100 percent Mortgages Work
A typical 100 percent mortgage or pledged-asset mortgage requires little or no cash down payment. Instead, you pledge securities in your brokerage account in lieu of a down payment, allowing you to finance up to 100 percent of the value of your home. The amount of securities you will have to pledge can vary depending on the type of securities you pledge and the terms of the mortgage. The amount you pledge usually exceeds the amount required, thereby allowing for some fluctuation in the value of the securities. However, if value of the securities you pledged goes down below a minimum amount set by the firm, your firm may issue a collateral call, which is a demand that you deposit additional cash or securities. If you can't do so or the value of the securities continues to decline, your firm may sell some or all of your securities, sometimes even without notifying you.
100 percent Mortgage Costs
Since you are borrowing more money with a 100 percent mortgage, you are probably paying more interest than you would have paid if you had made a cash down payment. This may make sense if you're able to achieve returns on your investments that are greater than your mortgage payments, but there can be no assurance that you will enjoy these investment returns. Moreover, if you choose an adjustable-rate 100 percent mortgage and interest rates rise, the returns in your investment portfolio may not keep up with your rising mortgage payments, particularly if you have bonds or other fixed instruments, which typically decline in value when interest rates rise. Even worse, with an adjustable-rate mortgage, if the securities markets decline at the same time that interest rates rise, you may be stuck with both larger mortgage payments and thousands of dollars in market losses. By contrast, if you sold your securities to come up with a cash down payment, you not only would have avoided any risk to those securities of a market decline, but you also would have a smaller mortgage and probably pay less interest.
100 percent Mortgage Risks
It is important that you fully understand the risks involved with 100 percent mortgages. These include:
- Even after you obtain your mortgage loan, you may be required to deposit more cash or securities if the value of the securities you pledged falls below the minimum required by your firm. A decline in the value of the securities you use as collateral for a 100 percent mortgage may require you to provide additional cash or securities to your firm to avoid the forced sale of those securities. 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?
- Your firm can force the sale of pledged securities to meet a collateral call. If the value of pledged securities falls below the minimum amount set by your firm, the firm can sell the securities you pledged. The cash received from the sale of securities then remains in the account until:
- the mortgage is repaid or refinanced;
- you instruct the firm to use the funds to pay down the mortgage;
- the equity in your home reaches a certain level, allowing the collateral account to be closed; or
- the cash is applied to the outstanding mortgage balance upon default, if necessary.
- Your firm can sell your securities without contacting you. While most firms will attempt to notify their customers of collateral calls, they are not required to do so. Even if you're contacted and provided with a specific date to meet a collateral call, your firm may decide to sell some or all of your securities before that date without any further notice to you. For example, your firm may take this action because the market value of your securities has continued to decline.
- You are not entitled to choose which securities are sold. There is no provision that gives you the right to control liquidation decisions. Your firm may decide to sell any of the securities that are held as collateral for your mortgage.
- You are not entitled to an extension of time on a collateral call. While an extension of time to meet a collateral call may be available to you under certain conditions, you do not have a right to the extension.
- If you default on your mortgage (stop making your monthly payments), you could lose both your home and the securities you pledge. Some states allow your firm to immediately sell your securities if you default on your mortgage. Other states only allow your securities to be liquidated after your house is sold for a loss at a public sale.
Do Your Homework!
- Shop around for the best mortgage for you. Mortgages are available from several types of lenders — banks, mortgage companies, and credit unions. Along with some brokerage firms, these financial institutions can offer a wide selection of mortgages and terms from which you can choose. Shop around, compare costs, and negotiate the best deal.
- Make sure you fully understand how a 100 percent mortgage works. It is important to take time to learn about the risks involved in 100 percent mortgages. Consult with your broker or lending officer about any concerns you may have with your mortgage.
- Know your firm's collateral call policies. Read your pledge agreement and other loan documents. Speak with your broker or lending officer if you don't understand these policies.
- Consider pledging a diversified portfolio rather than a single stock. Diversification can reduce the possibility of a collateral call because it is less likely that a variety of investments, such as stocks, bonds, and cash, will move up and down in value at the same time or at the same rate.
- If you use securities as collateral for a mortgage, you may not want to pledge all your available securities. Unless you have other liquid assets, you may not want to pledge all your securities; instead, retain some securities or cash so that you can promptly meet a collateral call demand to pledge additional cash or securities.
- Manage your pledged securities. Monitor the price of your pledged securities on a daily basis. If you see that the securities in your account are declining in value, you may want to consider depositing additional cash or securities to attempt to avoid a collateral call. If you receive a collateral call, act promptly to satisfy the call. By depositing cash or additional securities, you may be able to avoid your firm liquidating or selling the securities that it chooses.
Where to Turn for Help
If you have a problem with the brokerage firm that recommended a 100 percent mortgage strategy that the firm did not resolve to your satisfaction, you can file a complaint online at FINRA's Investor Complaint Center.
To learn more about finding a mortgage that's right for you, read the Federal Deposit Insurance Corporation's (FDIC) Looking for the Best Mortgage.
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* Most brokerage firms use a subsidiary, affiliate or separate bank to administer their mortgage program. For the purposes of this Alert, "brokerage firm" and "firm" refers to both the brokerage firm and any other entity that administers a mortgage program offered through the brokerage firm.