What is ‘Pledged Asset’
A pledged asset is transferred to a lender for the purpose of securing debt. Homebuyers can sometimes pledge assets, such as securities, to lending institutions to reduce the necessary down payment. Thus, these securities would not have to be sold to meet the down-payment requirements, allowing for capital appreciation while maintaining the associate mortgage benefits.
BREAKING DOWN ‘Pledged Asset’
The type and amount of pledged assets for a loan are negotiated between the lender and borrower. Because pledged assets give lenders a sense of security, pledged-asset loans typically provide borrowers better interest rates than unsecured loans.
A pledged-asset mortgage is recommended more for a borrower in a high income tax bracket. The mortgage may be a good choice if the investment used as collateral has a greater rate of return than the interest on the loan, or if selling the assets would result in paying higher taxes. A pledged-asset mortgage may also help a relative become a homeowner without a cash down payment if the investment owner provides the securities as collateral.
With a traditional mortgage, the house alone is used as collateral for the loan. Banks require a 20% down payment, so buyers do not end up owing more than their home’s value. Without the down payment, the buyer pays a monthly fee for private mortgage insurance (PMI) and a potentially higher interest rate. In contrast, borrowers with a pledged-asset mortgage may avoid paying PMI or being charged a higher interest rate by providing securities and the home as collateral.
Qualifying for a Pledged-Asset Mortgage
When qualifying for a pledged-asset mortgage, the borrower typically needs a higher value of securities than the down payment would be on the home. If the securities’ value drops, the bank may require that the borrower put more money in the account. Assets in an individual retirement account (IRA), 401(k) or other retirement account may not be used. The borrower transfers the assets into an account the lender controls. The borrower may still trade securities within the account, although riskier types of trading such as options trading or buying low-value stocks may be prohibited.
Pros and Cons of a Pledged-Asset Mortgage
A pledged-asset mortgage lets the borrower keep assets in potentially lucrative investments and avoid tax penalties associated with selling the assets. However, the borrower could lose both the home and the securities if he defaults on the mortgage. This is an especially important consideration when providing collateral for a relative’s pledged-asset mortgage. In addition, by not making a down payment, interest is paid on the full price of the property. The borrower may make a profit from the investment being used as collateral, but the ability to trade is limited if the investments are stocks or mutual funds. Overall, the borrower may end up spending more than necessary on the home with a pledged-asset mortgage.