Pros and Cons of Using Securities as Down Payment

June 7, 1999 "I can either put 20% down to avoid mortgage insurance, or I can invest the 20% in stock held by my broker, who would then finance 100% of the value of the house with no mortgage insurance. Assuming the rate and points are the same, is the broker plan a good idea or a bad idea?" Your security broker and a number of others have home loan plans where they accept the deposit of securities in place of a down payment. If you purchase a house for $200,000, for example, the broker will lend you the entire $200,00, provided you deposit securities worth $40,000 with the broker. For the broker, the securities provide essentially the same protection against default as a down payment, while discouraging the customer from shifting the account to another broker. These plans delay the accumulation of equity in the house indefinitely. The customer begins with no equity, and if the payment only covers the interest for the first 10 years, which is a common feature, the only equity buildup that occurs is from appreciation in the value of the property. The theory behind this is that the consumer's overall wealth will grow more rapidly if the maximum amount is invested in securities. In the example, the consumer is in effect borrowing an additional $40,000 to invest in securities. Whether this turns out to be a good idea or a bad idea depends on the yield earned on the securities relative to the mortgage rate. It doesn't make sense to borrow $40,000 at 7% to invest in Government bonds yielding 5.5%. The consumers who do this are investing in common stock, which they expect will yield 12-20%, as has been the case for some years now. If this continues to be the case in the future, the securities plan will turn out well. If the stock market collapses, of course, it will turn out to have been a bad idea. Copyright Jack Guttentag 2002

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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