Important points
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The idea of using home equity for investment is attractive, especially given the current rise in home values and the strong performance of the stock market.
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But it comes with significant risks, including investment volatility, the potential for significant financial loss, and even loss of your home.
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Factors to consider include the amount of equity you own, the strength of your credit score, and the cost of borrowing (loan interest rate and other fees).
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Alternatives include buying stock on margin or doing a cash-out refinance. Both have lower interest rates than home equity loans or HELOCs.
Even if your home values are ahead in today’s luxury housing market, you may still feel woefully behind in other aspects of your financial life. The latest edition of the Bankrate Retirement Savings Survey found that more than half of Americans (57%) feel behind in their current retirement savings levels. Only half (49 percent) of people with financial retirement goals in mind feel like they’ll likely have enough savings to reach that magic number. Especially since one in three people (35 percent) think they need more than $1. I need $1 million to survive for a few years after work.
Saving alone won’t work. Investing is the key to building a nest egg and making other big expenses and dreams come true. But to make money, you need money. If you don’t have enough income to invest, should you consider borrowing specifically from home equity, the value contained in real estate? After all, it’s the wealth you (literally) sit on. Its value has probably increased recently. Why not take the initiative to pursue growth opportunities?
While leveraging and investing your home equity may sound like an attractive strategy, it comes with serious risks. Here’s what you need to know:
Why you might want to use home equity as an investment
Why do people want to use their home equity as an investment? Because they have a lot of it. One reason for this is that the unprecedented rise in house prices/property values over the past few years has made equity investments more expensive. But unlike dividend-paying stocks, appreciated homes don’t give you any positive returns. You can’t access that wealth unless you sell it or borrow money.
Next, let’s look at trends in the stock market. Despite major setbacks at the start of the COVID-19 crisis and again in 2022, the overall market has performed well, with an annualized return of 11.33% over the past five years. In 2023, the S&P 500 returned more than 26%. It has increased 21% so far in 2024 (as of early November).
In fact, the whole rent-to-invest strategy has paid off a lot during the pandemic. At the time, the market was posting double-digit gains, while interest rates on home equity loans and home equity lines of credit (HELOCs) were depressed. It’s been hovering around 4% or less.
True, since then borrowing has become more expensive. Home equity interest rates have doubled compared to the low to low era. But interest rates have been steadily falling since the Federal Reserve began cutting rates in September. And with the prospect of further Fed interest rate cuts in the near future, some borrowers are eyeing the potential intersection of cheaper loans and home appreciation as an opportunity to increase their wealth.
The idea has particular appeal for young homeowners between the ages of 28 and 43 who are stretching themselves to buy a home and don’t have much in savings or retirement accounts. When Bankrate’s Home Equity Insights survey asked homeowners to justify using their equity, 30 percent of millennial homeowners said they would “make other investments” (“other”). (meaning things other than housing).
Older homeowners, such as Gen Xers and baby boomers, were less optimistic about leveraging their home equity for investment. According to the Home Equity Insights Survey, only 13% and 8% respectively think it’s a good idea.
What can I invest my home equity in?
Once you receive your funds after closing a home equity loan or HELOC (the most common way to leverage equity), you can use them to invest in just about anything, including stocks, bonds, mutual funds, ETFs, real estate, and more. (However, check with your financial institution. Some prohibit the use of home equity for investments or as a down payment for a mortgage on the remainder of the property.)
It’s important to think about what type of investments you want to pursue. Let’s say you want to get into real estate. Investing in REITs (Real Estate Investment Trusts) is convenient, but control of real estate is completely out of your hands. In contrast, purchasing an investment property in an area with historically proven rental demand can provide a predictable source of income. Plus, you can have a little more control. If the tenant doesn’t bite, you can lower the rent or lease.
Additionally, some small business owners use home equity financing to bet on themselves. If you’re developing a business plan, a home equity loan or HELOC may help you secure the funding you need to take your venture to the next level. .
Is it a good idea to leverage your home equity to invest?
When Brian Baker, CFA, senior investment and retirement writer at Bankrate, comes to him with questions about leveraging their home equity for investments, he advises them to be “very careful.” He said he would advise.
“While investing that money in something like stocks may sound like a good idea given the potential for high returns, stocks can be very volatile in the short term.” Baker says. “It is not unusual for stock prices to fall by more than 20% in a short period of time.”
Casey T. Smith, president of Georgia-based financial advisory firm Weiser Wealth Management, echoed those concerns. “When markets are as high as they are now, there tends to be a sense of greed, and we often get questions about borrowing money to invest,” Smith says. “The reality is that the market could fall by double digits at any time for a variety of reasons.”
And such a decline can easily wipe out profits. That’s why it’s important to look at the average performance of the market over several years. This is especially important when you’re also dealing with decades-long debt, as home equity loans and HELOCs typically are. Over the long term, stock markets typically rise, but the overall returns are not as dramatic as a single year would suggest.
Average stock market performance over time
period | Average return, S&P 500 | Inflation-adjusted average return, S&P 500 |
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Past 5 years (2018 to 2023) | 11.33% | 7.28% |
Past 10 years (2013 to 2023) | 12.39% | 9.48% |
Last 20 years (2003-2023) | 9.75% | 7.03% |
Last 30 years (1993 to 2023) | 9.90% | 7.22% |
Source: Macro Trends, SoFi |
Risks of using home equity for investment
So what are the main drawbacks of using home equity as an investment?
- You have more debt: There are several ways to leverage your home equity. But no matter which path you choose, the outcome is simple. Your overall debt will increase. More debt means higher monthly payment obligations, which can affect your lifestyle and your ability to save for emergencies.
- You could lose your home. The worst-case scenario for home equity loans is simple. If you miss a payment, the lender could repossess your home. That’s why almost all financial planners advise against borrowing capital and going into debt to invest. No matter how great it sounds to get huge returns on your investments, don’t let your brain cloud the realization that you need a roof over your head.
- You could lose a lot of money. You never know what the outcome of your investment will be. It could go up or it could go down. However, you know exactly what your lender expects you to make on-time payments each month. If your investments do not perform well, you can easily incur a net loss. “Customers need to be able to repay their loans with confidence while watching their investment fall below the loan amount,” Smith says. “Even worse, what happens if we have a recession like we had in 2008 and homeowners lose their jobs at the same time?”
What should I consider before using my home equity as an investment?
If you are afraid of considerable risk and are not walking away from this strategy, you should think about two important questions.
Do you consider yourself wealthy? If the answer is yes, this is the only way Smith advises to leverage your home equity. “When[people]have a $5 million home, or multiple $5 million homes, it’s very difficult to keep all that cash sitting there,” Smith says. “They typically leverage these assets and reinvest in their own businesses or other non-traditional investments. These families typically earn more than $1 million annually from multiple sources. and the risk is reduced.”
How much home equity do you have? Even if you’re not ultra-rich, are you at least equity-rich, meaning your mortgage balance is less than half the value of your home? When deciding how large to extend your HELoan or HELOC, lenders will Consider the total amount of all home-based debt, including any loans. Frankly, paying off most of your mortgage is the only way you can borrow a lot of money to play with.
Is your credit strong? The robustness of your credit score and other financial circumstances play an important role in the interest rate you are offered. The higher your score, the lower your interest rate. Of course, this applies to any loan, but it’s especially important here because you want the spread between your return on investment and the cost of borrowing to be as wide as possible. Mortgage borrowers tend to have high scores. According to the Mortgage Bankers Association, the average FICO score in 2023 was 742 for a HELoan and 760 for a HELOC. That leads us…
What do I pay to borrow money?You have to consider the interest rate someone is paying on the loan,” Baker says. “If you’re paying 8% interest, your investment has to outperform that amount, which is a pretty high bar.” Consider that the stock market averages a 10% annual return. The average interest rate on home equity loans is currently around 8.50%, so based on historical trends, your return will exceed your cost of borrowing by about 1.5%. This is only if the stock market returns 10% per year. It’s a close call, and that interest rate average is the base interest rate, not the APR of the entire loan. Some home equity loans and HELOCs have closing costs. These tend to be less than mortgages, but can still amount to up to several thousand dollars for a five-figure loan.
Calculate home equity costs and investment returns
Let’s look at the diagram below and consider the equilibrium interest rate method that Mr. Baker emphasizes.
Loan period | 10 years |
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interest rate | 9% |
amount | $50,000 |
monthly payment | $633.38 |
lifetime profit | $26,005.46 |
In other words, it’s not as simple as borrowing $50,000 and paying back $50,000 to make a profit. Instead, you’ll need an investment that pays out a minimum of $76,005.46 over 10 years. This is just the break-even point. In order to make a profit, you need to earn more profit.
You may also need to be aware of income tax and capital gains tax implications. Additionally, inflation can erode the purchasing power of the money in your investment account. It’s tempting to show that you can win by taking advantage of the stock market’s 10% annual average, which adds up to more than $135,000 compounded daily, but the reality is that returns over several years… When something goes wrong, plans can easily go awry. plan.
Alternatives to using home equity as an investment
As you can see, leveraging home equity to make money is harder than it looks. Here are some alternatives.
- Credit trading: If you must borrow to invest, buying on margin may be the preferred method. Basically, you purchase securities with a loan from a securities company. The lowest margin interest rate is more affordable than current home equity loan rates, and of course doesn’t put your home at risk. However, this route also comes with many risks. Especially if the value of the investment you borrowed to buy falls. The brokerage firm will then ask you to provide more funds, and if that is not possible, it will sell your holdings or other stocks to make up for the losses. This means you can lose more money than you originally invested.
- Personal loan: Personal loans are worth considering as an investment. Also, a key benefit is that these unsecured loans do not put your home at risk. However, if you don’t have great credit, personal loan interest rates can be sky-high (think around 30%). Note that the interest rate must be higher than the borrowing rate.
- Cash-out refinance: A cash-out refinance leverages the value of your home, but perhaps in a more advantageous way. This involves exchanging your current mortgage for a larger loan and pocketing the difference between the two. The lump sum you receive is based on your equity in your home equity. A cash-out refinance instead of a HELoan avoids two monthly payments and refinance rates tend to be lower than home equity rates. But of course, applying for a new mortgage can be a pain and may come with a higher interest rate than your current mortgage.
Key points of using home equity for investment
Between soaring home prices and headlines of record stock market returns, now is an attractive time to leverage your home equity for investment. However, if you are not a financial expert, investing with borrowed funds is always controversial, and the risks are increased if you are borrowing against your home equity.
Home equity financing is a large amount of long-term debt. Financial investments tend to increase in value over the long term, but they do not necessarily increase in value on the same schedule as loan repayments. And given that while HELoan and HELOC costs are relatively low, they are still significant costs, so even breaking even can be difficult.
Fundamentally, it comes down to whether the investment return can outweigh the interest rate and other costs of borrowing. At first glance, this math seems to make sense, but upon closer inspection, the numbers often don’t add up enough to make it worth the risk. Especially if that risk involves the roof above your head.