walkitout (walkitout) wrote,
walkitout
walkitout

Margin Rate Loans for Real Estate

People do this. I KNOW! WHY???? Two reasons: the amount they want to borrow is too high even for a jumbo, or at least a jumbo that they can find (or, see below: there is a benefit for being able to access the money faster than a conventional loan). Or because they can't _get_ a mortgage because they can't show enough income to satisfy current loan requirements.

What's a margin loan? Well, let's say you have an investment portfolio that you have been shoveling all the money that you save into over a period of years/decades (and it's not a 401K or IRA or Roth IRA or whatever, either because you don't qualify for one of those or you've maxed it out or whatever). In that portfolio is a bunch of stocks, funds, bonds, etc. You've carefully crafted a diverse set of investments over time (or you are holding a huge amount of stock in a company that you helped found/work for) and you don't want to (can't because of special insider trading rules that apply to you) sell the underlying stocks, funds, bonds, etc. Nevertheless, even tho you (a) don't have the cash, (b) can't or don't care to borrow the money in the form of a mortgage against the house (see first paragraph) or (c) can't or don't care to sell assets to generate the cash, you still want to buy a (ludicrously expensive) piece of real estate.

The firm you have the assets at is often willing to loan you money _against_ those assets, in exchange for (a) interest and (b) the right to sell those assets and take the money back that way. So instead of borrowing from a bank that can take your house, you are borrowing from an investment company that can take your ... investments. And generally, the scenario under which they would sell your investments to get their money back is ... in the middle of a crash, when they are worth A Lot Less.

Margin loans for real estate are a terrible idea, because they let people spend insane amounts of money -- after all, this tends to happen when stock portfolios are super plump and people are reluctant to sell because, I dunno, no one wants to sell at or near the peak? they always think it's gonna go higher, and it will, until it doesn't -- running up the price on real estate. And then the assets guaranteeing the loan ... shrivel, and are sold at a loss (either by the "owner" or the other owner, that is, whoever you borrowed the money from), thus making an already expensive decision to buy that real estate even more expensive (to be fair, selling the underlying asset to buy the real estate can have the exact same effect, minus some of the drama).

I know, it's terribly funny because it only happens to people who (a) have a lot of money and (b) are stupid. But it is actually a serious problem in a ton of ways, because this is a bubble. And it is really happening. And it will tend to encourage people to want interest rates to rise to slow down the bubble, AND THAT WILL GUARANTEE YOU NEVER GET A RAISE EVER AGAIN (or more hours or a job at all). While you are busy laughing at stupid rich people, crudely managing their stupidity may result in a whole lot of unavoidable pain for everyone else. Let's not do this.

The first step in Not Doing This is understanding that it is happening, talking about it so we all understand it, and then crafting tools to discourage or eliminate the behavior. We are Not There Yet, because this is the quality of advice out there about margin loans and real estate. Is it opposed to the practice? Yes, yes it is. Is it cogent and concise? Not at all.

http://www.bankrate.com/finance/mortgages/margin-loan-or-mortgage-to-buy-a-home.aspx

The argument here is basically, "it's too risky". And if the person whose broker is trying to get them to use a margin loan to buy a house takes "it's too risky" back to the broker, the broker is JUST GOING TO TALK FASTER. And then the idiot will be an idiot. Which may turn out fine, but probably not.

"Margin loans are variable-rate loans. The interest rate will vary among brokers. A quick review of current rates finds great variation. A 15- or 30-year fixed-rate mortgage appears to be a bargain compared with what some brokerage firms charge. Are you willing to move your account to get the lowest margin loan rate?

There are plenty of other risks if using margin to finance your home. Aside from interest rate risk, you face the possibility of a margin call if the value of your investments declines."

Other coverage of margin loans to buy real estate, scary to think this is, in part, what is driving the California real estate market this go-round:

http://www.marketwatch.com/story/using-a-margin-loan-to-buy-a-house-2013-07-25

At least _they_ point out that margin call risk is huge and that some people are just using the margin loan to win a bidding war for a house, and will then line up more traditional financing later. But horrifying, that this has become so normal in the last couple years, and this article is mostly about how to do it better, rather than about how it needs to stop.
Tags: economy
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