The Money Mustache Community
Learning, Sharing, and Teaching => Real Estate and Landlording => Topic started by: xenon5 on February 23, 2015, 08:11:14 PM
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Hey All,
I recently learned about a financial product called a Pledged Asset Mortgage, and interestingly enough I wasn't able to find any discussions on the MMM forums about them or much of anywhere else. Here's Merrill Lynch's info page about this product:
http://www.merrillhomeloans.com/mlhl/pages/100-percent-financing.aspx
And here's the short and skinny:
Instead of using a 20% cash down payment + house as collateral for the loan, you maintain a 40% pledged asset brokerage account + house to secure the loan. The value of the assets in the account must not drop below 33% of the purchase price.
For a $100k mortgage, you need to open a pledged brokerage account with $40k in assets that must remain above a set value until the mortgage is paid off or your equity is sufficiently high.
Of course, there's always a catch. Here's the pro's and con's:
Pros (Add "Assuming all goes well" to the start of most bullets ;) )
- Reduce the opportunity cost of buying - save for FIRE and a house concurrently and keep more money in the market. This saves you roughly $82.4k inflation adjusted dollars on a 30yr, $100k, 4% loan (calculations below!)
- Assuming asset liquidation for a traditional mortgage, no capital gains tax triggered
- Assuming no asset liquidation for a traditional mortgage, time between desire to purchase and purchasing can be much shorter, since you don't need to then save up a down payment
Cons
- If the pledged account drops in value, you may need to pledge more assets to the account
- If the account drops below 33% of the starting mortgage amount, the bank may initiate a collateral call and sell any pledged assets at any time without consent. You can't access these sold funds until you pay off, refinance, default, use the funds to pay down the mortgage or reach high enough home equity to close the pledged account
- If you default, you could lose both the assets and the house
- No idea what funds you can invest in within the pledge account. Expense ratios could be higher.
Alternatively you can use a pledged asset account for less than 100% financing with a small down payment. PMI is still not required and you can reduce the chances of failing to meet a margin call. For example, you might use a 10% down payment with a 20% asset pledge.
My impression is that it sounds great if things go well, but could be pretty awful in a market downturn. If I were to get such a loan I would want a much larger portion of the pledge account in bonds than in the rest of my portfolio to reduce the risk of needing to add more funds or dipping below the minimum 33% maintenance amount.
Also, it doesn't sound that significantly different than buying a home with a down payment, then using a HELOC for stock market leverage.
Has anyone here used this type of mortgage? What's your take? To me it sounds like a risky but rewarding strategy. But with a good ratio of held taxable to pledged assets, and no plans to touch those assets for several years anyway, the risk can be reduced.
And here's my saved opportunity cost calculation:
Assumptions:
- 2% mortgage interest (inflation adjusted -2%)
- 5% investment returns (inflation adjusted + slightly conservative to account for higher bond allocation)
Opportunity cost avoided = investment return of $20k invested @ 5% - interest cost of $20k @ 2%
OCA = 89k - 6.6k = $82.4k
Of course allocation and market returns means a large range of possible values.
See attached screenshots for calculator screenshots.
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It sounds interesting, but:
Alternatively you can use a pledged asset account for less than 100% financing with a small down payment to avoid incurring PMI and reduce the risks described above.
So you pledge 40% of the purchase price in assets, and they still charge PMI? I know the account value will fluctuate, but this seems crazy. How small of a down payment must you pay to avoid the PMI? If I could avoid PMI, I would absolutely be interested in a deal like this.
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It sounds interesting, but:
Alternatively you can use a pledged asset account for less than 100% financing with a small down payment to avoid incurring PMI and reduce the risks described above.
So you pledge 40% of the purchase price in assets, and they still charge PMI? I know the account value will fluctuate, but this seems crazy. How small of a down payment must you pay to avoid the PMI? If I could avoid PMI, I would absolutely be interested in a deal like this.
No, one of the main benefits of the asset pledge is that PMI is not required. What I meant in this statement is instead of using 0% down payment and 40% asset pledge, you use for example 5% cash down and 30% pledge to reduce the chances of failing to meet a collateral call while still avoiding PMI. I'm assuming a sliding scale between 0:40 and 20:0 for the cash down:asset pledge ratio.
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These loans were popular in the internet boom times of the late 90's. Then the market went bust and the collateral calls came.... Lots of people were wiped out. Would not touch one of these. They are like holding a burning firecracker.
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It sounds interesting, but:
Alternatively you can use a pledged asset account for less than 100% financing with a small down payment to avoid incurring PMI and reduce the risks described above.
So you pledge 40% of the purchase price in assets, and they still charge PMI? I know the account value will fluctuate, but this seems crazy. How small of a down payment must you pay to avoid the PMI? If I could avoid PMI, I would absolutely be interested in a deal like this.
No, one of the main benefits of the asset pledge is that PMI is not required. What I meant in this statement is instead of using 0% down payment and 40% asset pledge, you use for example 5% cash down and 30% pledge to reduce the chances of failing to meet a collateral call while still avoiding PMI. I'm assuming a sliding scale between 0:40 and 20:0 for the cash down:asset pledge ratio.
Gotcha. That makes more sense. I may have to look into this if/when I'm in the market for another mortgage.
These loans were popular in the internet boom times of the late 90's. Then the market went bust and the collateral calls came.... Lots of people were wiped out. Would not touch one of these. They are like holding a burning firecracker.
It might make sense if you chose a portfolio with reasonably low volatility but decent enough returns - something like a PP, perhaps? Particularly if you had the means to cover your ass if things went haywire, then it shouldn't be too risky. Just because people made bad decisions 15 years ago doesn't necessarily make it a bad tool.
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We have had clients do this in the past and a couple doing it now. There is a separate account that was pledged that we opened for the client and then transferred only what was needed into the account to keep everything else protected. We use Schwab. One client had a loan from an outside bank and the others had loans from Schwab. We could buy anything we wanted to in the account. If you have enough in taxable accounts, a potential margin call can be met by transferring from one account to the other and you can keep your normal allocation. Make sure you find out about account minimums if you want to do this. I want to say $250k or so was a minimum account size to do this with? I am sure that will vary from different brokers and banks.
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Sounds risky to me.
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No idea what funds you can invest in within the pledge account. Expense ratios could be higher.
You're trying to make a decision without information that should be obtainable. I wouldn't make any decision until you get this information. I mean, if the expense ratios are bad 401k fund ratios bad, then it may not be worth it.
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No idea what funds you can invest in within the pledge account. Expense ratios could be higher.
You're trying to make a decision without information that should be obtainable. I wouldn't make any decision until you get this information. I mean, if the expense ratios are bad 401k fund ratios bad, then it may not be worth it.
I wouldn't say trying to make a decision at this point - I don't have any taxable investments yet to begin with :) But I know charles schwab also offers this type of loan and they have etfs with competitive expense ratios to Vanguard. You'd likely be able to transfer assets to the account as well. If I were serious I'd call and ask about fund/etf availability before specifically saving up to do this.
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No idea what funds you can invest in within the pledge account. Expense ratios could be higher.
You're trying to make a decision without information that should be obtainable. I wouldn't make any decision until you get this information. I mean, if the expense ratios are bad 401k fund ratios bad, then it may not be worth it.
I wouldn't say trying to make a decision at this point - I don't have any taxable investments yet to begin with :) But I know charles schwab also offers this type of loan and they have etfs with competitive expense ratios to Vanguard. You'd likely be able to transfer assets to the account as well. If I were serious I'd call and ask about fund/etf availability before specifically saving up to do this.
Oh my bad.
Assuming you get competitive ETFs.... I agree with your assessment
My impression is that it sounds great if things go well, but could be pretty awful in a market downturn.
The following isn't a dealbreaker so long as you view all of your accounts as one big portfolio, and you just put most of your bond allocation in this pledged asset account.
If I were to get such a loan I would want a much larger portion of the pledge account in bonds than in the rest of my portfolio to reduce the risk of needing to add more funds or dipping below the minimum 33% maintenance amount.
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I don't see the advantage over using regular margin. Is the interest rate fixed? The maintenance margin is way worse -- value can only fall 17.5% before a margin call?
I'd put my assets in Interactive Brokers instead. Worst case, your initial margin is 50% but ideally you have more assets. Value can fall 33.3% before you hit the 25% maintenance margin (possibly better if you use portfolio margin). Interest rates are very low and tax deductible against certain income if done correctly.
So using a million dollar house:
You put 400k stocks in your brokerage.
You withdraw 200k in cash.
Use the 200k as a 20% down payment on the house at say 4%
Pay, say 1.5% on the down payment.
No PMI.
Don't know if every bank is ok with this, but mine was. I did this (sorta).
edit: elaborating on the "sorta." I didn't withdraw cash from existing assets. Instead, I accumulated my savings in a checking account. Instead of depositing these savings to IB and buying more stocks, I just bought more stocks on margin - but I had the cash to pay it off in checking. This means the margin interest is tax deductible against my bond interest. I used the cash in checking as a down payment. I'm also not concerned about a margin call because my total leverage is quite small (nowhere near 2:1) and I have other sources of cash to pay off the balance when interest rates go up or if a big crash comes.