Falling stock prices could trigger collateral call -- requiring quick cash from borrower
By MortgageDaily.com staff
5/24/2004

Securities regulators recently warned investors about the risks of mortgages from brokerage firms that allow them to pledge their securities in lieu of a down payment.

The National Association of Securities Dealers (NASD), which says it regulates virtually every securities business in the nation, recently issued an Investor Alert to inform investors about often overlooked risks associated with 100 percent loan-to-value ratio mortgages, also known as pledged-asset mortgages.

The regulator said brokerage firms often tout the advantages of these mortgages such as allowing investors to avoid private mortgage insurance or liquidating their stocks, bonds, mutual funds and other securities to come up with a down payment.

However, "these 100 percent mortgages are not suitable for everyone, and investors should approach them with extreme caution," said Mary Schapiro, an NASD vice chairman, in a statement. "Many investors aren't aware of the considerable risks involved. We're especially concerned that they don't understand that the securities they pledge in lieu of a down payment may be liquidated if the value of those securities drops below a certain level, or if they default on their mortgage."

The NASD warned that brokerage firms may overlook, or consign to the fine print, the risks involved with such mortgages.

Even after the mortgage loan is obtained, if the value of the securities pledged falls below the minimum required by the brokerage firm, the company can issue a "collateral call" -- a demand that the investors deposit additional cash or securities in their brokerage accounts, NASD said. The brokerage can force the sale of securities in an investor's account to meet a collateral call and do so without contacting the investor. Additionally, investors are not entitled to choose which securities in the account are sold nor can they ask for an extension of time to meet the demand. In the case that investors default on their mortgage, they could lose both the house and the pledged securities.

NASD also pointed out that because more money is borrowed with a 100% mortgage, investors probably pay more interest than if they used a cash down payment. While borrowing more can make sense if the returns on investments are greater than the mortgage payments, there is no assurance that this will be the case. If there is a decline in the securities market and interest rates rise at the same time, investors can end up with both larger mortgage payments and thousands of dollars in market losses. By selling securities to come up with a cash down payment, investors may have a smaller mortgage, pay less interest and can avoid risks involved with a securities market decline.

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