Investing In The Stock Market
Investing in the stock market comes with no guarantees. However, watching the growth of the S& P 500 over the past 10 years may encourage some homeowners to use their home equity loan proceeds to invest in the markets, in hopes that theyll get a return larger than what theyll pay in interest.
Taking a loan out against a property to try to capture the next unicorn is incredibly risky, says John Mazza, president and CEO of Summerfield Wealth Advisors and former financial adviser with Southeast Financial Services in Greensboro, N.C. Everybody wants the unicorn, but slow and steady wins the race with the markets.
Best Of Both Worlds: Refinance And Invest
If youre still on the fence about which option is best, you may not need to choose between paying your mortgage early and investing. Rather, you can take a two-pronged approach to reducing your debt and growing your wealth.
Mortgage rates are at historic lows, which means its a great time to refinance. If you took out your mortgage or last refinanced years ago, its likely that you can save quite a bit of money by refinancing to a lower interest rate and/or reducing your mortgage term length. Thats true whether or not you also choose to pay down the loan more aggressively. Just be sure to factor in closing costs when running the numbers.
With your newfound mortgage savings in place, you can go ahead and invest, too. This allows you to spend less on your mortgage overall while still taking advantage of the higher returns of the stock market.
How Do We Maintain Such A High Rate Of Return
Thats where the other three pillars come into play: weve invested heavily in technology and automation that helps us connect with and service both borrowers and investors directly.
Automated processes and technology-enabled services mean we can reach both investors like yourself and thousands of borrowers without the need of costly middle-men who exist to shave off value through referral and management fees.
Instead, we pass these savings directly to the investor, and in offering best-in-class rates to borrowers. All of this means we continue to grow and diversify the portfolio while maintaining great, lower risk returns when compared to the rest of the real estate investment market.
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Drawbacks Of Investing Your Extra Cash
- Higher risk: There is more volatility in the stock market than in the housing market year over year, so you should be sure your investing timeline is long enough to weather ups and downs. You also need to make sure that your investment strategy matches your risk tolerance and youre mentally prepared to take some hits.
- Increased debt: Choosing to invest your money may not be the best option if you dont like the idea of having debt to your name. Until your mortgage is repaid, you dont actually own your homethe bank does. And there will always be some risk that you could lose your home if you arent able to make the payments.
Who Should Consider Taking Out A Personal Loan To Invest
In my opinion, only people with investments that have guaranteed returns and very little to no risk should take out a personal loan to invest. These investments rarely exist.
The risk isnt worth the relatively low amount youll earn over the interest costs of the loan in the vast majority of cases.
This means most people should avoid taking out a personal loan to invest.
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Getting A Second Mortgage
A second mortgage is a second loan that you take on your home. You can borrow up to 80% of the appraised value of your home, minus the balance on your first mortgage.
The loan is secured against your home equity. While you pay off your second mortgage, you also need continue to pay off your first mortgage.
If you cant make your payments and your loan goes into default, you may lose your home. If thats the case, your home will be sold to pay off both your first and second mortgages. Your first mortgage lender would be paid first.
Interest Rates And Fees If You Borrow On Amounts You Prepaid
You pay either a blended interest rate or the same interest rate as your mortgage on the amount you borrow. A blended interest rate combines your current interest and the rate currently available for a new term.
Fees vary between lenders. Make sure to ask your lender what fees you have to pay.
You may not have to make any changes to your mortgage term.
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Using Home Equity To Invest Is A Terrible Idea Period
Maybe this is the first thing that came to your mind. Its a valid argument for a lot of people. The Dave Ramsey fan in me thinks this.
But Dave Ramsey is pretty extreme on the conservative side.
Irresponsible people who dont pay attention to their finances should not borrow against their homes for anything. The majority of the population fits into this category. These are the people that never get ahead of the curve. Theyre the strapped and reliant side of this chart.
I used to agree with Dave. However, my views have changed as my wealth has increased and in light of perpetually low rates.
Putting on my investor hat
Personal Loans Have A Fixed Term
Next, personal loans are fixed-term loans. This means you have a set number of months or years to repay the loan after you take it out.
Based on your balance, interest rate, and term, youll have to make a payment each month that results in paying off the loan at the end of the term.
This is unlike a credit card where you can carry a balance from month to month and make minimum payments.
This is important if youre considering investing the money. It means you have to make a fairly decent monthly payment each month. You cant pay the minimum and pay the rest off at the end of the loan.
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Questions To Ask Yourself
Thinking about borrowing to make an RRSP contribution?
Youll get a tax deduction for your contribution, but make sure you can afford the loan payments. Interest you pay on money you borrow to invest in an RRSP is not deductible. It can add up and offset the initial benefit of making the contribution. Learn more about borrowing to invest in your RRSP.
Borrowing to invest can be an effective strategy, but its not for everyone. Taking on this kind of debt can be very risky.
Use this calculator to see how long it will take you to pay down debt at different interest rates.
Why Would Someone Take Out A Loan To Invest
A person may be tempted to take out a personal loan to invest if they see an opportunity to make money. If a person could earn higher returns investing the money they borrow than they pay in interest, they could come out ahead.
This can be very tempting after a stock market crashes and then starts rebounding. In some cases, you may see sharp gains for a few days or weeks that would exceed the costs of some personal loans over a year.
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Paying Off Credit Card Bills
The average credit card APR is now about 16%, so using a home equity loan to pay off high-interest credit card bills can be smart.
After all, some banks offer home equity loans with rates around 5%. If you transfer high-interest credit card bills to a home equity loan with a rate that’s less than a third of what you’re paying on your credit cards, you could save money and pay down debt faster.
Here’s an example:
Imagine you have $10,000 in credit card debt at 17% APR. If you made a minimum payment of $300 each month, you would spend 46 months paying it off and fork over $3,629 in interest in the process.
If you transferred that debt to a home equity loan at 5.49%, on the other hand, things look totally different. With the same $300 monthly payment, you could pay off your debt in just 37 months and pay only $875 in interest.
This And Other Personal Finance Questions Are Answered
In this episode of Motley Fool Answers, with the help of Motley Fool Wealth Management financial planner and tax expert Megan Brinsfield, we’re answering your questions about finding or becoming a professional financial planner, using your stimulus check to jump-start your child’s retirement savings, and lots of tax stuff.
To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on March 30, 2021.
Alison Southwick: This is Motley Fool Answers. I’m Alison Southwick, and I’m joined as always by Robert free-frappa-lula Brokamp, personal finance expert at The Motley Fool.
Robert Brokamp: Where the helicopter did that come from?
Southwick: Hey, in this week’s episode, it’s the March Mailbag and we’ll be answering your questions on using home equity to buy stock, reducing required minimum distributions, and botching the backdoor Roth. All that and more on this week’s episode of Motley Fool Answers.
Hey, Megan Brinsfield is back. She heads up the team of financial planners over at Motley Fool Wealth Management.
Brokamp: A sister company of The Motley Fool.
Southwick: Beautiful. We’re so excited to have you back answering your questions. What’s fun is Bro didn’t realize that that was coming, and he was going for a sip of water right at the exact moment, so good job, Bro.
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Paying Back Margin Loans
As long as your account equity stays above 25 percent, there is no requirement to make payments or pay off a brokerage margin loan. If your stocks go up or you add cash to the account, you can buy more shares and increase the size of the loan. Your broker will charge interest on the loan, which will be added to the outstanding loan balance. You can choose to pay down the loan at any time, using the cash in your brokerage account. A cash balance can come from stock dividends, selling shares or making a deposit.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor’s degree in mathematics from the U.S. Air Force Academy.
Leveraging Home Equity Line Of Credit To Invest
Using funds from a home equity line of credit to invest in dividend stocks would be similar to the scenario above, but with a few major differences.
- Youd likely have access to a significantly larger sum of money since the funds are secured by the equity in your home. Of course, that also increases your risk since your home could be at stake if youre unable to make the interest payments.
- If you arent disciplined about paying back the money you withdraw from your HELOC, you could end up paying more in total interest over time, even if your rate is low.
- Borrowing and investing a larger sum of money might make it psychologically harder for you to stay invested if theres a market downturn. For example, a 20% annual market loss on a $10,000 investment is $2,000, but the same percentage loss on a $100,000 investment is $20,000. And that loss may feel even more acute when you add the fact that your investment may be worth less than the outstanding debt on your HELOC.
To recap, leveraging your HELOC to invest could be a smart strategy if you:
- Have a lot to gain through the interest tax deductions
- Are certain youll be able to make your interest payments with ease and have a plan to pay back the principal
- Plan to invest for at least 10 years and will stay in the market even if you experience sizable annual losses.
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Using Home Equity For Investment Or Rental Properties
You can typically use a home equity loan or HELOC to purchase or work on a rental property as most lenders dont have restrictions on how you use the money.
Using your home equity to make a down payment or to fully purchase a rental property may be a good idea because it can help you secure low rates without having to go through the process of getting a second mortgage.
A home equity loan or HELOC can also be a good source of cash to make repairs or improvements on an investment property because the interest rates are usually much lower than other forms of borrowing, like credit cards and personal loans.
Most lenders will have a maximum combined loan-to-value ratio of around 85%. This means that your mortgage and home equity loan cant exceed 85% of your homes current value.
For example, if your home is currently worth $200,000 and you have a mortgage balance of $120,000, your current loan-to-value ratio would be 60%. The maximum amount of debt you could haveincluding your mortgage and home equity loanis $170,000 . This means the total amount of a home equity loan you could receive is $50,000 .
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Option : Conventional Bank Loans
If you already own a home thatâs your primary residence, youâre probably familiar with conventional financing. A conventional mortgage conforms to guidelines set by Fannie Mae or Freddie Mac, and unlike a Federal Home Administration , U.S. Department of Veterans Affairs , or U.S. Department of Agriculture loan, itâs not backed by the federal government.
With conventional financing, the typical expectation for a down payment is 20% of the homeâs purchase price. With an investment property, however, the lender may require 30% of funds as a down payment.
With a conventional loan, your personal and determine both your ability to get approved and what kind of interest rate applies to the mortgage. Lenders also review borrowersâ income and assets. And obviously, borrowers must be able to show that they can afford their existing mortgage and the monthly loan payments on an investment property.
Future rental income isnât factored into the debt-to-income calculations, and most lenders expect borrowers to have at least six months of cash set aside to cover both mortgage obligations.
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Why We Opened A Heloc
We opened a home equity line of credit on our primary residence at the end of 2014. We used our bank and mortgage holder after vetting competing rates.
I wrote the first version of this blog post a few months later. Republishing it five years later, I hope to add some wisdom Ive learned from the experience.
Back then, I wanted to have access to our home equity if ever needed, but we didnt have a specific plan to use the money.
Access to equity has always been cheap and tempting. We used a small portion to help fund our minivan purchase , and it helped to smooth out monthly expenses when our monthly cash flow was tight.
But I maintain enough self-control not to use it to buy things I dont need.
Its a line of credit instead of a loan, meaning we can tap into it whenever we need it. The payment varies based on how much we use, but the interest rate is low compared to other loan vehicles.
Over the years, Ive asked myself many times, would it be smart to borrow money against my house using our HELOC and invest the loan into something else?
Ive always said no. But frankly, it might have been a missed opportunity. Since January 1st, 2015, the S& P 500 is up more than 50%! My variable HELOC rate has hovered around 5%, but the bank sometimes offers fixed-rate advances closer to 3%.
I dont think Id ever deliberately borrow against my house to invest in stocks. But I might consider profitable real estate opportunities.
Advantages Of Using Home Equity On An Investment Property
Using funds from a home equity loan or HELOC is often a smart money move for many consumers. Here are some of the key advantages of doing so:
- Low interest rates. As compared to unsecured forms of debt, such as personal loans, home equity loans and HELOCs have low interest rates, making this an inexpensive form of borrowing.
- Utilize the equity youve built. Though you may not realize it, your home equity is a part of your net worth. It is, however, much harder to get your home equity to work for you like you can with savings and investments. With a home equity loan or HELOC, you can utilize your equity to grow your money.
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