How To Use Equity To Invest In The Share Market
When it comes to borrowing money to invest, property often springs to mind. But did you know that real estate isnt the only investment avenue you can explore? You could also use your equity enter the stock market and invest in things like individual stocks, managed funds and exchange-traded funds .
Once youve established yourself as a homeowner, you might be thinking: okay, whats next? If youve achieved your goal of getting into the property market and paid down some of your mortgage, you could start looking at other paths to diversify your investments and build wealth.
One way is to leverage some of the equity in your home to start investing in the share market. This kind of investment is more risky than investing in property, so its important that you proceed cautiously and seek out professional advice before you press ahead.
On the other hand, if youre looking at borrowing to invest, equity may give you a way to do that at the interest rate you have on your home loan which is likely much lower than those available on credit cards or margin loans.
But first, we need to determine how much equity you might have to work with.
To Pay Off Car Loans Or Credit Cards
A cash-out refinance can be a good idea if your home has gone up in value. It is often the best option if you need cash right away and you also qualify to get a better interest rate than on your first mortgage.
If your credit score is much higher than when you purchased your home, then a lower rate can help offset the higher payment that will come with a larger balance that includes the cash-out amount. If you use the cash-out amount to pay off other debts, such as car loans or credit cards, then your overall cash flow may improve. Your credit score may even rise enough to warrant another refinance in the future.
Looking At The Question Wearing Different Financial Hats
Over the years, Ive read a lot of books and blogs of pundits with strong beliefs. Ive also invested quite a bit myself and made some consequential financial decisions.
Through my experiences, I look at the core question, is it smart to borrow against your home to invest?, with many different hats on.
First, Ill put on my pragmatist hat
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How Borrowing On Home Equity Works
You may be able to borrow money secured against your home equity. Typically, interest rates on loans secured against home equity can be much lower than other types of loans.
Not all financial institutions offer home equity financing options. Ask your financial institution which financing options they offer.
You must go through an approval process before you can borrow against your home equity. If youre approved, your lender may deposit the full amount you borrow in your bank account at once.
You can borrow up to 80% of the appraised value of your home.
From that amount, you must deduct the following:
- the balance on your mortgage
- your total HELOC amount, if you have one
- any other loans secured against your home
Your lender may agree to refinance your home with the following options:
- a second mortgage
- a loan or line of credit secured with your home
Positives Of Investing Your Home Equity
Your home equity provides some downside protection for you in case you need to sell your home when you move. If you owe $160,000 on a $200,000 home you can probably sell the home at a discount, pay your realtor fees, and still pay off the loan. You might walk away with nothing, but your equity covers the losses you incur.
But if you never plan to move you could have a lot of money sitting in your home not earning any kind of return. Your home equity doesnt pay interest, so anything you can do to generate a positive return after lending costs is a good financial move. As noted, the stock market has historically returned 10%. Home mortgage rates are currently in the high 3% and low 4% range. That is an all time historic low. You could borrow money at 4%, and even earning a return of 5 or 6% would mean more money in your pocket.
You could also get lucky and take that $40,000 in home equity and generate a 500% return in the first year. That would be enough to completely pay off the mortgage and cash out refinancing loan you took to invest.
But when something sounds too good to be true, it probably is
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See If The Property Has Appreciated In Value
If your property is in a high-growth area or youve owned it for a number of years, the property may appreciate in value over time without you doing anything. However, depending on changes in the property market, the reverse could also happen. With that in mind, it may be worth keeping up to date with market trends to see how your property is faring.
Invest In Ways To Grow Your Income
Rather than investing in stocks or real estate, which are subject to unpredictable market forces, consider spending the money on enhancing your potential to earn more down the road. “You could take it out to start a business or help with college costs,” says Hale. “These are the types of investments that are a little more guaranteed.”
Of course, not every business idea is a surefire winner. Entrepreneurship experts generally recommend taking on as little debt as possible to get your business off the ground: Even if it’s a success, it can sometimes be years before it generates a steady income. “Using to start a business can be precarious,” says Mock. “There are other types of loans out there that won’t put your home at risk.”
In other words, if you want to use your home equity as seed funding for a business, make sure you don’t quit the day job that will allow you to consistently pay your new mortgage.
You could take it out to start a business or help with college costs. These are the types of investments that are a little more guaranteed.Danielle HaleChief economist, Realtor.com
A safer bet is paying for education, either for yourself or a child, says Hale. “We know that people with degrees tend to earn more income,” she says. “Sending yourself or someone else to college is a surer way to enhance their income in the future.”
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Investing In Home Improvements
Whether youre looking to improve your home to get it ready to sell or just want to give your living space an update, using your home equity to invest in home improvements is a popular decision. Plus, certain improvements can even increase your homes value above and beyond their sticker price, helping you build even more equity in your property.
There can be a downside to this, though. Its important that homeowners research the types of home improvement projects that offer the best returns in their area. Some may not be worth the expense, especially if youre only making the improvements to boost your homes resale value. This is especially true for very personalized remodeling projects.
Lastly, consider when to invest in home improvements based on how long you plan to stay in the house. If its your forever home, this doesnt matter so much. If youre planning to sell, though, you may want to enjoy your efforts before selling the property, especially if your improvements dont retain as high of a resale value.
How Do You Know Where To Invest
If you want to take equity out of your home, the goal is that youre earning more than the interest rate on your loan. There are a lot of ways you can do this.
For example, you could invest in the stock market or a real estate investment trust .
Other financially wise ways to invest the equity in your home include:
To secure a stronger financial future, you might consider tapping into your homes equity to pay off high-interest-rate debt. For example, if you have a credit card with a 16% interest rate, and you get a loan with a 3.5% interest rate, youre going to get yourself out of debt faster, and youre going to reduce what youre paying in interest significantly.
Investing in real estate can be a smart way to use your homes equity. For example, you might use the money from your home equity to then put a down payment on a rental property.
Starting a business is a way to invest in your future, although its risky.
The goal, if youre considering now as the optimal time to tap into your equity, is to invest in something thats going to generate income. You want to pay back your loan with income so that you grow your wealth for the future.
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The Hidden Benefits Of Downsizing
Many retirees decide to downsize in retirement, and doing so comes with potential added benefits â you can cut many home-related expenses. The Center for Retirement Research at Boston College found that empty-nesters were spending 30% of their income on property taxes, insurance, maintenance and utilities.3
The question for downsizers then becomes what to do with all of the unleashed capital. âThereâs no single right answer,â says Imundo. âYou and your advisor can look at all of the options to help figure out what might work best for what you want to achieve.â Then you can move on to focus again on the people and things that matter most to you â and create new memories, perhaps in new places.
1 Gallup, âWhat Percentage of Americans Own Stock?â August 13, 20213 Center for Retirement Research at Boston College, âIs Home Equity an Underutilized Retirement Asset?â 2017
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Merrill, its affiliates, and financial advisors do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Buying A Home Using A Home Equity Line Of Credit
With CIBC’s Home Power Plan®, you can take advantage of the equity you have in your existing home to buy another property. You can combine a line of credit and a mortgage, in order to consolidate all of your personal credit under one simple, low-interest and secured borrowing solution, which can be adjusted to meet your changing needs.
You can also use this line of credit even if you don’t currently own a home.
Whether you’re looking at purchasing a primary or secondary residence, there are pros and cons to buying with a home equity line of credit as opposed to a traditional mortgage.
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Weighing Up The Pros And Cons
Using equity is a great option to potentially lock in a better interest rate, and avoid paying Lenders Mortgage Insurance . Keep in mind that the property youre taking equity from will become additional security for your new loan as well we call this cross-collateralisation. In the future, this means any decisions you make to one loan or property may impact the other.
For example, if you sell one property later, the money from the sale may be used to reduce your other loan. It all depends on the value of the property youre keeping and how your remaining repayments might impact your situation.
What Is The Three
This federal rule says you have three business days, including Saturdays but NOT Sundays, to reconsider a signed credit agreement that secures your principal residence and cancel the deal without penalty. The Three-Day Cancellation Rule applies to many home equity loans .
You can cancel for any reason, but only if youre using your main residence as collateral. That could be a house, condominium, mobile home, or houseboat. The right to cancel doesnt apply to a vacation or second home.
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Under The Rule Can I Waive My Right To Cancel The Contract
If you have a personal financial emergency like damage to your home from a storm or other natural disaster you can waive your right to cancel. That eliminates the three-day waiting period so you can get the money sooner. To waive your right:
- You must give the lender a written statement describing the emergency and stating that you are waiving your right to cancel.
- The statement must be dated and signed by you and anyone else who also owns the home.
Your right to cancel gives you extra time to think about putting your home up as collateral for the financing to help you avoid losing your home to foreclosure. If you have a personal financial emergency, you can waive this right, but be sure thats what you want before you waive it.
Useable Equity And Investing In Shares
Once youve established the amount of useable equity available, you may be able to use these funds to invest into the stock market. The most common types of investments are shares, individual stocks, managed funds, index funds, ETFs and retirement accounts .
There are a couple of options for accessing the equity in your home to invest, both with different pros and cons that you should weigh up in line with your financial situation.
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How To Leverage Home Equity
There are a few ways homeowners can tap into the equity theyve accumulated.
One option is a home equity loan. This type of loan is similar to a traditional mortgage, which is why its also sometimes referred to as a second mortgage. Home equity loans are installment loans, which means the funds are disbursed in one lump sum and paid back over time in equal payments. Theyre also backed by you guessed it your homes equity. Usually, home equity loans have a fixed rate thats a bit higher than the primary mortgage but can be much lower than rates on other types of borrowing.
Another way to leverage home equity is through a home equity line of credit, or HELOC. Unlike a home equity loan, a HELOC allows you to borrow against your equity repeatedly and then pay off the balance, much like a credit card. Some HELOCs require that a minimum amount is disbursed initially, but there are no closing costs. Many HELOCs also provide a debit card and checks that you can use to easily access the funds.
There is one more option known as a cash-out refinance. Rather than taking out a secondary loan or line of credit, this involves refinancing the mortgage for a higher amount and taking the difference in cash. Even though you dont necessarily take on an additional loan with this method, you still increase your overall debt load and pay closing costs.
How Home Equity Works
The most common ways to access the equity in your home are a HELOC, a home equity loan and a cash-out refinance.
To tap into your homes equity through one of these options, youll need to go through a process thats very similar to obtaining a mortgage. You can apply through a bank, credit union, online lender or another financial institution that offers these home equity products.
Lenders will consider multiple factors, including a persons debt-to-income ratio, loan-to-value ratio, credit score, and annual income, says Michele Hammond, senior home lending advisor at Chase Private Client Home Lending. Additionally, to determine the amount of equity in a home, a lender will employ an appraiser to determine the current market value of the home, which is based on its conditions and comparable properties in the area.
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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.
Using A Home Equity Line Of Credit As Leverage
As mentioned above, its easy to obtain leverage if youve amassed equity in your home or a property that you already own. You simply need to approach your bank for a home equity line of credit, also known as a HELOC loan. You can then use this HELOC loan leveraging your home equity to buy another home in Canada or to buy a rental property. You can use equity to buy another house.
Lets take the $400K property from above and lets say you still owe $200K on your mortgage. In this scenario, you can still borrow $200K , at roughly 3% or $6K each year, which over five years would amount to $30K.
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For Home Improvements Or Launching A Business
A HELOC is a good fit for homeowners who need access to cash periodically over a span of time. These expenses are usually incurred on an ongoing basis. A HELOC can be used for a series of home improvements, for example, or for launching a small business.
HELOCs are generally the cheapest type of loan because you pay interest only on what you actually borrow. There are also no closing costs. You just have to be sure that you can repay the entire balance by the time that the repayment period expires.
During the coronavirus pandemic, most banks have still been offering these loans. However, some institutions have raised their requirements for credit scores and loan-to-value ratios. In addition, Wells Fargo and JPMorgan Chase announced freezes on applications for new HELOCs.
Mortgage lending discrimination is illegal. If you think that youve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One such step is to file a report with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development .
