10.0David P Neuman
(720) 599-3505

Investment Fraud and Broker Negligence

Use of Home Equity to Invest

Use of Home Equity to Invest

For many Americans, their primary residence is often their largest asset.  Within the last 10 to 15 years, some Americans wanted to tap into that asset and use home equity loans to invest in the stock market.  With the rising level of real estate prices during the first half of the 2000’s, some financial advisors recommended that their clients take out equity in their homes and use those proceeds to invest in the market.  However, this strategy was subject to risk (sometimes substantial risk).  When housing prices collapsed in 2007-2009, many investors who utilized this strategy suffered immense losses.

The NASD (the predecessor of FINRA) warned financial advisors about the risks of such a strategy in NASD Notice to Members 04-89.  The specific concerns that the NASD warned advisors about are the following:

NASD believes that a recommendation for a homeowner to liquefy home equity for investments poses significant and unique risks for investors. A home is a basic necessity and is often an individual’s largest asset. Home-ownership also provides stability and plays an important part in many social policies.

One of the primary concerns of investing liquefied home equity is that an investor may lose his or her home. If a homeowner takes out a mortgage to invest in securities on the assumption that the return from the investments will be sufficient to cover the mortgage payments, and the investment fails to earn the necessary rate of return, the investor may be unable to meet his or her mortgage obligations and default on the mortgage.

Another concern is that investors may misapprehend their risk tolerance for investments using liquefied home equity, particularly since liquefying home equity may often have an accompanying increase in mortgage obligations or create a new obligation in the case of a home equity line of credit. Thus, if the value of an investment decreases, as can happen with many investments, the investor may need to sell his or her investments to protect his or her home and limit further losses.

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Members are reminded that recommending liquefying home equity to purchase securities may not be suitable for all investors. Members should consider not only whether the recommended investments are suitable, but also whether the strategy of investing liquefied home equity in securities is suitable.  In addition to the factors typically considered as part of a suitability analysis, a member and its associated persons also may wish to consider: (1) how much equity does the investor have in his or her home; (2) what is the level of equity being liquefied for investments; (3) how will the investor meet his or her increased mortgage obligations; (4) is the mortgage or home equity loan at a fixed or variable rate; (5) what is the investor’s risk tolerance with respect to the funds being invested; (6) what is the investor’s overall debt burden; and (7) what is the sustainability of the value of the investor’s home.

In addition, members also are reminded that IM-2310-2 (Fair Dealing with Customers) prohibits recommending purchases beyond a customer’s capability, stating that it is a violation of a member’s responsibility of fair dealing to “recommend[] the purchase of securities or the continuing purchase of securities in amounts which are inconsistent with the reasonable expectation that the customer has the financial ability to meet such a commitment.”

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…NASD believes members recommending investments of liquefied home equity should pay particular attention to providing investors with adequate risk disclosure. Among the risks and conflicts of investing liquefied home equity are: (1) the potential loss of one’s home; (2) the fact that unlike other potential lenders, the member has an interest in having the proceeds of the loan used for investments that may generate commissions, mark-ups or fees for the member; (3) the member or its affiliate may earn fees in connection with originating the loan; (4) the impact of liquefied home equity on the ability to refinance a home mortgage; and (5) depending on the amount of home equity liquefied and any change in home value, the homeowner may have negative equity in his or her home.

Members also should pay particular attention to their sales materials and oral presentations concerning investments of liquefied home equity. NASD reminds its members that the promotion of liquefying home equity must be fair and balanced, and must address the associated risks.

For example, if a member presents a scenario in which the investment returns from liquefied equity will be sufficient to pay the costs of accessing such capital, the member should highlight the risk that such returns may not be achieved and that the customer may have to access additional sources of funding to pay the mortgage or equity line of credit or risk foreclosure.

Members also should consider the extent to which accounts investing liquefied home equity should require heightened supervision or specific account approval.

See NASD Notice to Members 04-89 at 2-4 (emphasis added).

The NASD also warned investors about this same problem in a March 2004 article called “Betting the Ranch: Risking Your Home to Buy Securities.”  This article presents a hypothetical which is relevant here:

A retired couple’s house is paid off, but they have very little extra money to meet their everyday living expenses. They decide to take out a new mortgage of $250,000 at 6 percent, seeking to invest this mortgage money in the hope of making more than 6 percent. They lock into a mortgage requiring monthly payments of $1,663. On the advice of their broker, they invest their mortgage money in a mutual fund that has earned an average of 12 percent over the past five years. But instead of gaining value, the couple’s investment loses money from the start and continues to decline. After one year, their investment is worth $200,000. Since they were depending on this investment to generate $1,663 per month to pay the loan and have no other assets to liquidate to make up the difference, they are faced with a tough choice: Sell off part of their now depleted original investment to pay the mortgage payments and hope that the investment turns around, or sell their house and hope that the selling price is enough to pay off the loan and pay for real estate commissions. Either way, they run the risk of losing money—and their home.

See “Betting the Ranch” at 1 (emphasis added).

The securities and investment fraud attorneys at Israels & Neuman PLC have offices in Denver, Colorado and the Seattle area.  We represent investors in FINRA arbitration proceedings in all 50 states.  Our attorneys have represented over one thousand investors against many brokerage firms in the past, including LPL Financial, Merrill Lynch, Morgan Stanley, Smith Barney, Stifel Nicolaus & Company, UBS Financial Services, Oppenheimer, Charles Schwab, Wells Fargo Advisors, Ameriprise Financial Services, Raymond James Financial Services, ProEquities, Securities America, National Securities Corp., and many others.

All of our financial arbitration cases are taken on a contingent fee basis, meaning that we do not get paid unless we recover compensation for you.


                Aaron Israels: (720) 599-3505

                David Neuman: (206) 795-5798

10.0David P Neuman

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