Tapping into Home Equity to Buy Stocks is a Very Risky Proposition

Stocks have soared in value the last several years, and a dangerous investment strategy is creeping back into the market: financial advisers may soon recommend that clients tap the equity in their home to buy stocks.

Proven disastrous for thousands of investors in the crashes of 2000 and 2008, this so-called strategy posits that investors can take advantage of a rising stock market and pull cash out of their homes via a low interest home equity loan. They then plow those loan proceeds into the stock market and get fat and happy from the returns and dividends.

It sounds enticing, particularly as the broad stock market continues to crest near record highs and record low interest rates crimp the returns on traditional savings products like bank CDs.

The recent disastrous history of this strategy, however, shows that the risks are clearly not worth the benefits. During and after the tremendous tech stock bubble in 1998 – 2000, investors employed a similar strategy. Many ended up with tremendous debts and even lost their homes as stock prices sharply plummeted during the bursting of the bubble.

Similar stories came to light after the crash of 2008, often made worse because they were orchestrated by scam artists who used clients’ cash from home equity loans to fund Ponzi schemes that promised yields two to three times the rate of the new mortgage payment. The conman’s pitch was simple and effective for retirees looking for income. Refinance your home equity loan, give me the cash, and I will generate enough of a return so you can make the mortgage payment and have enough to live comfortably.

Following the 2000 tech bubble and crash, FINRA (previously NASD), the investor protection unit, warned brokerage firms against recommending or facilitating investments of liquefying home equity. According to FINRA’s warning from 2004, it believed that a “recommendation for a homeowner to liquefy home equity for investments poses significant and unique risks for investors”, including that the investor “may lose his or her home.” According to FINRA, if 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.”

FINRA also warns that “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.”

Unfortunately, this recent history hasn’t prevented some financial advisers and business journalists from proposing it could be useful to tap into your home equity.

For example, Jonathan Yates, a Benzinga staff writer, penned a recent article entitled “3 Reasons to Tap into Home Equity to Buy Stocks.” Yates posits that “buying stocks with the proceeds of a home equity loan diversifies the portfolio” of the investor. Yates suggests that “there are many stocks that have dividend yields higher than mortgage rates” and that as a result, investors can “practice a form of interest arbitrage.”

He also argues that “stocks are much more liquid than real estate” and that it is a “wise financial move to convert illiquid assets into ones that can be sold when needed.”

Unfortunately, Yates, and many financial advisors, don’t discuss the tremendous risks investors are taking when they engage in tapping home equity for stock purchases. This is an ultra-high risk strategy that has destroyed the most valuable asset of many Mom and Pop investors: their homes.

In the recent past, investors have watched years of home equity wiped out after weeks of a rapidly declining stock market. Stay away from this strategy.

Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.

About Jacob H. Zamansky 57 Articles

Jacob (”Jake”) H. Zamansky is one of the country’s foremost authorities on securities arbitration law, the legal recourse for investors claiming broker wrongdoing, or for brokers claiming wrongful termination or other misconduct by their employer. Zamansky & Associates, the New York-based law firm he founded, represents both individuals and institutions in complex securities, hedge fund, and employment arbitrations.

Mr. Zamansky was at the forefront of recent efforts to “clean up” Wall Street. In 2001, he successfully sued former Merrill Lynch analyst Henry Blodget on behalf of a New York pediatrician misled by Blodget’s stock research. The case’s successful resolution was the catalyst for New York Attorney General Elliot Spitzer to investigate the conflicts of interest on Wall Street and resulted in the well-reported $1.4 billion Global Settlement, which included many of the biggest names on Wall Street.

More recently, Mr. Zamansky is one of the leading litigators and opinion leaders of the subprime mortgage crisis and the related hedge fund collapses, representing both investors and mortgage borrowers who were defrauded by Wall Street firms and mortgage lenders. Among Mr. Zamansky’s early actions is filing the first arbitration case on behalf of institutional and high net worth investors against Bear Stearns Asset Management with regard to the two hedge funds which collapsed as a result of exposure to subprime mortgage backed securities. He also has filed claims on behalf of individual investors victimized by brokers that steered their portfolios into unsuitable subprime stocks and mortgage borrowers who were fraudulently coerced into inappropriate mortgage and investment transactions.

Earlier in his career, Mr. Zamansky worked for more than 30 years as a litigator, including positions at Skadden Arps, Slate, Meagher and Flom LLP. His tenure also included serving as a federal prosecutor with the Federal Trade Commission.

A native of Philadelphia, Mr. Zamansky has been a frequent expert commentator on CNBC, CNN, and FOX News and has published opinion pieces in The Wall Street Journal, Financial Times and USA Today. He is regularly quoted and his cases have been chronicled in major financial and news publications including The New York Times, USA Today, The Washington Post, BusinessWeek, Fortune and Forbes. He is a frequent lecturer for industry and legal groups around the country. He also writes a blog that can be viewed here.

Visit: Zamansky & Associates

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