The US economy is stalling because the average consumer is overburdened with debt. The answer is for everyone to live below their means, pay down debt, and generate passive income from investments.
But that sounds boring. The easy answer is to offer everyone the ability to assume more debt. That’s precisely the route the federal government wants to take.
Freddie Mac wants to create a secondary market for home equity loans, also known as secondary mortgages. According to Sofi.com, this could create a new trillion-dollar debt industry.
Happy Cash Flow Retirement 10
Today, I want to explain secondary markets, home equity loans, and how you can profit from this new capital market. Also, whether you should assume a home equity loan or not. Let’s begin.
What is a secondary market? I talk a lot about mortgage-backed securities (MBS) because they are an essential secondary market that maintains liquidity in the real estate business.
Your bank ensures your primary mortgage loan conforms to the standards set by Freddie Mac and Fannie Mae. If your loan conforms, these government entities guarantee investors that they will purchase the mortgage if you default.
Banks do not want to hold large $500,000+ loans on their books for 30 years. In fact, they want to offload these loans to someone else as soon as possible.
Enter the secondary mortgage industry. Large industry players purchase these mortgage loans from banks in bulk and package them together to form mortgage-backed securities.
Individual Treasury Bonds vs. Treasury Bond Funds
An MBS can contain thousands of mortgages. Mortgage-backed securities trade on the bond market; therefore, investors can purchase them below, at, or above par based on market conditions.
As soon as banks sell your mortgage loan to industry players (after collecting fees from you), they can create another mortgage loan for another buyer.
Why home equity loans? Why now? We are in a recession now (May 2024). Inflation and job losses have caused consumers to slow down their spending.
The longer the recession drags on, the more businesses and banks will suffer. Corporate profits have taken a massive hit in late 2023 and early 2024.
The US economy runs on consumer spending, and the government needs people to either become spending conscious OR access more debt—they want to take the debt route.
Can the Military Elevate You to the Middle Class?
Freddie Mac now wants to guarantee home equity loans that conform to its standards. This ensures that these riskier assets can obtain investment-grade status. Large entities like pension funds, private equity, and college trusts can access investment-grade debt.
I also assume a secondary MBS (SMBS) market will open. I expect SMBS to trade on the bond market next to their bigger brother, MBS.
Will consumers take home equity loans in mass? I absolutely expect homeowners to fall into the home equity loan trap en masse. Americans love debt—plan and simple.
The first rule is that your current primary mortgage needs to conform to Freddie Mac’s guidelines. Second, the total between both loans needs to fall under 80% of your property value. Let’s look at an example.
Selling Cash-Secured Puts for Passive Income
Let’s say Josh and Kris own a home valued at $600,000. They owe $200,000 on the primary mortgage, which leaves them with $400,000 in equity and a loan-to-value ratio of 33%.
The 80% loan-to-value ratio for a $600,000 home is $480,000. Therefore, they could borrow $280,000 in a home equity loan. I’m sure there will be a cap (perhaps $200,000) to ensure homeowners don’t get themselves in trouble like in 2008.
Should you take a home equity loan? A home equity loan makes sense only if you purchase an income-producing asset like real estate, a business, or stocks.
Even then, that’s much more risk than the average homeowner should take. I would only take a secondary mortgage to purchase a home for my kids, free and clear.
This is Why I Became a Writer
I would rent the home to pay the new home equity loan, plus rent a room in my current primary residence to pay the loan even quicker. I am more hardcore than most.
Also, I understand that I would likely need to purchase a home in a smaller city than where I reside. For example, it would be tough for a San Diego homeowner to buy a house for their kids in San Diego.
A better way to profit from SMBS. A better way to profit from secondary mortgages is to purchase them on the stock market.
One of my favorite types of income-investing products is Mortgage REITs (mREITs), which purchase MBS using leverage. mREITs generate high returns (12-17%) through dividends.
Inside Our $240,000 Dividend Portfolio
I will assume that mREITs will get involved in secondary mortgages or new smREITs (Secondary Mortgage REITs) will emerge that deal specifically with a bundle of home equity loans.
Secondary mortgages should offer higher interest rates for investors because they assume more risk. Homeowners will attempt to pay their primary mortgages first, then their secondary.
However, with Freddie Mac as a sponsor, secondary mortgages should offer the same credit risk as US Treasuries and Mortgage-Backed Securities—same risk, higher returns.
So, if a leveraged mREIT can offer 12-17% returns, a leveraged smREIT may offer 14-20% returns. I think secondary mortgages will trade in the same interest rate range as junk bonds, with far less risk.
Closed-End Funds vs. Dividend ETFs
We don’t know how this plays out. I know that homeowners should avoid getting a secondary mortgage unless they purchase another home.
Beware of false profits. All bets will be off once banks get the green light that the US government is backing their home equity loans.
Banks already know what’s remaining on your mortgage loan and the value of your home. They will send you an offer with the exact amount you can borrow. Expect an offer in the mail saying you can extract $100,000 ($200,000 with jumbo loans) from your home without much fuss.
It may sound like a dream come true until you get an $800 monthly bill in the mail. The average consumer is not a sophisticated investor, and banks know this.
Financial Security vs. Financial Freedom 2
In 2008, banks were not ready to assume foreclosed homes from distressed borrowers. Today, they probably have a list of private equity, foreign investors, real estate investment trusts, and institutional investors lined up to assume distressed properties.
This means that if you get behind on your secondary mortgage, banks will be there to foreclose on you quickly. There will not be a repeat of 2008 when millions of homes sat empty.
Conclusion. Smart investors and consumers will avoid secondary mortgages until they have their own financial house in order.
When the new debt market opens, there will be a race to the bottom. Banks will want to create and offload as many secondary mortgages as possible before new regulations appear.
Passive Income: How Do You Spend Your Freetime?
Beware. Stay diligent. If this new market creates a housing dip, even those with a little common sense and financial prowess could find great opportunities.
Remember, home insurance and property taxes are already average pressing the average homeowner. Adding another $800 to $1,000 per month will not help.
If you have a paid-off home, a home equity loan may be a great way to access new capital to purchase a home for your kids. Otherwise, I recommend staying away.
I am watching this new trillion-dollar market from afar. My brokerage account is ready to purchase new debt securities, but that will be the primary way I access secondary mortgages. Adding debt in a recession is like adding grease to a fire. Good Luck!
- PDF of the Month: Don’t Gamble with Retirement 12 (Free 460-Page PDF)
- Free PDF Downloads: Download FREE PDF LIST here
- Financial Mindset: Become CEO of Yourself 2 (Free 196-Page PDF)
- Retirement Planning: Your Retirement Planning Guide 2 (Free 255-Page PDF)
- Investing: How We Plan to Retire on Dividends 4 (Free 139-Page PDF)
- Cryptocurrencies: Counting on Crypto 2 (Free 159-Page PDF)
- Real Estate: Financial Independence through Real Estate 4 (Free 112-Page PDF)
- Business: Retire Rich, Retire Comfortable with a Business 4 (Free 149-Page PDF)
- Latest DGWR: Don’t Gamble with Retirement 11 (Free 410-Page PDF)
- Everything!: The Biggest Book on Passive Income Ever 4! (book)(Web Edition)(Art Edition)
- Writer’s Comparison: M1 Macbook Air vs. GalaxyBook3 Pro 360
- Read My Books for Free: Free Kindle Books Schedule
- Book Design: Design Tips on YouTube
- Kindle Unlimited: Why I Finally Subscribed Kindle Unlimited (learn more)
- Book Reviews: 505 Takeaways from 101 Books (pdf)
- Writing: The Publishing Chronicles (Part 1, Part 2, Part 3, Part 4, Part 5)
- Best REIT- Fundrise: Fundrise vs. US Treasuries (Join Fundrise)
- Follow us: On our Facebook Page and Join our Facebook Group
- Support the Channel on Cash App: $Kingmarine1981
- For more detailed analysis, join my Youtube: MFI YouTube Channel
PDF of the Month: Don’t Gamble with Retirement 12 (Free 460-Page PDF)
Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
Leave a Reply