A Risky Way to Buy a Home

The most adventurous buyers might be interested in financing their purchases with little-known vehicles called pledged-asset mortgages. These loans allow consumers to use their investment portfolios as collateral for mortgages — rather than gather together a traditional down payment — while still qualifying for the most competitive mortgage rates. The benefit: Rather than tie up money in real estate, they can remain invested elsewhere. (We'll explain the mechanics later.)

Risky? You bet.

Pledged-asset mortgages are available only to those with sizable investment portfolios — and thus much to lose. Should the stock market fall and the investments pledged as collateral drop in value, holders could be faced with the equivalent of a margin call. And if they can't come up with the money to satisfy the call, their personal balance sheets could look like Enron's circa 2002.

Pledged-asset mortgages aren't new: Large brokerage firms began offering them in the early 1990s, as the stock market began to soar. At the time, pulling money out of the stock market to invest it in boring old real estate seemed anything but desirable — and therefore these loans seemed attractive. But when the technology bubble burst, the products fell out of favor, explains Darren Weisberg, president elect of the Illinois Association of Mortgage Brokers.

Nowadays, however, the NASD (formerly the National Association of Securities Dealers) worries that these loans could start garnering more attention. Last year, for example, Charles Schwab began offering pledged-asset mortgages.

The rationale for pledged-asset mortgages is simple: As predictions of a real-estate bubble proliferate, the stock market might soon seem like a safer investment. Folks who believe stocks will outperform real estate in the future — as they have for most of the last 100 years — might choose to hang onto their winners and avoid paying the capital gains taxes and transaction fees their brokers charge.

Even if you agree with this outlook, is a pledged-asset mortgage right for you? We'll be honest: Probably not. In fact, the NASD has issued an "Investor Alert" warning people of the risks of these loans. But in certain circumstances, they can make sense. Here's what you need to know.

The Basics
How does a pledged-asset mortgage work? It's a bit like buying a house on margin.

Borrowers set aside a portion of their investment portfolio, say, 35% to 45% of the home's value, into a separate "pledge" account that acts as collateral for a 100% mortgage. While they still own the securities in the account, their trading activities are limited. They get a mortgage through their broker, and aren't socked with nasty private mortgage insurance payments that typically accompany mortgages with less than 20% down. (Retirement accounts can't be used as collateral for pledged-asset mortgages.)

Should the assets in the pledge account drop below a predetermined level, say, 110% of the required pledge amount, the borrower could get what's known as a collateral call. When this happens, the borrower is required to deposit cash or other securities into the account to prop it back up to appropriate levels.