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Betting the Ranch: Risking Your Home To Buy Securities

Contributed by mm | March 18, 2004 10:58 AM PST

NASD published this usual Investor Alert against a growing trend of taking equity out of real estate and put to the stock market. NASD wrote:

There is risk to principal when you invest in virtually any security. Taking money out of your house to buy securities compounds your risk for the following reasons:

When you buy securities with mortgage money, you are investing with borrowed funds. While this increases your buying power, it also increases your exposure to market risk, similar to buying securities on margin. The difference is your mortgage loan is likely to be greater than any amount a securities firm would loan you on margin. Investing borrowed mortgage money amounts to a huge bet that the investment will increase.

Unlike investing with savings, when you invest with mortgage money, you stand to lose more than your principal if the investment goes sour. You can lose the collateral supporting the loan¡ªnamely your house. Even if you don't lose your house, you could lose the equity in your home that may have built up over a considerable period of time.

You may put your money in higher risk investments than you might normally select, in an effort not only to match the rate of your home loan but in the hopes of surpassing this rate. Furthermore, with so much at stake, if a given investment does poorly, you may feel compelled to move your investment into even more risky investments to make up the difference, further jeopardizing your home, credit standing, and overall financial health.

In the cited example, a retired couple took out all the equity in their once-paid-off home by a 6% mortage to invest in the stock market, only to see their brokerage account shirnk by 20% in one year and face the harsh reality.

My taking is: one's personal financial portfolio should always include some low-risk elements like home and saving accounts. Unless you are a sophisticated investor and understand the risk you are taking, you should not bet your home in the stock market. (And if you do decide to try your luck, you should take out an ARM mortgage to make your opportunity cost as low as possible -- the 6% mortgage in the above example is apparently a 30-year fixed rate mortgage.)

Source: The Kirk Report

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