Should You Invest Your Home's Equity?
- Monday, September 19, 2005
If you are a homeowner, some financial experts and investment magazines say that you may be sitting on "dead equity." They would like to help you bring it back to life — and enrich themselves in the process.
"Too many people simply look at their home as a place to live," says Sheila Delutri of Merrill Lynch Financial Advisors. What follows is a suggestion that homeowners actually withdraw the built-up equity from their homes and invest the proceeds in the stock market.
Dead equity is any equity in your home that isn’t somehow "working harder" for you elsewhere. Sure, your home "works" for you because it is appreciating in value, but this brand of advice suggests you transform that appreciation — namely by borrowing and leveraging it — into even greater rates of return elsewhere. Like municipal bonds. Or the stock market.
That’s just what folks like Ira Carnahan recently had in mind. "When you buy a new house," he advised in the December 2004 issue of Forbes magazine, "Take out the biggest mortgage you can without incurring a higher interest rate, even if you have spare cash. Invest the cash instead."
Carnahan, and other high-rung financial advisors, argue that paying down your mortgage is an inefficient use of money. Mortgage borrowing they advise, allows you access to large amounts of relatively inexpensive money — money that could then be used to your advantage.
Consider that 1) mortgage rates are low compared to other borrowing rates; 2) mortgage rates are effectively made even lower by their tax-deductibility; and 3) over the long term, money (supposedly) works most productively when it’s invested in stocks.
These gurus’ advice? Invest money in stocks before paying extra on your mortgage.
The idea here (borrowing money against your home at low rates and pouring those funds into potentially higher-returning investments) has some merit. Retirement investing via 401(k)s and IRAs probably should be emphasized before making large efforts to pay down one’s mortgage. That home, after all, won’t feed you in retirement.
The annual rates of return you earn on your retirement investments stand a decent chance of surpassing what you’d save yourself in interest if you paid off your mortgage early. And investing in retirement accounts can offer tax advantages and company matches.
But nice ideas can be taken to dangerous extremes.
Financial advisors and investment magazines occasionally suggest that homeowners actually withdraw the built-up equity from their homes and invest the proceeds in the stock market. In doing so ("stripping" in industry jargon), you’re borrowing money against your home at say, 6 or 8 percent. Tax deductibility makes that rate somewhat less, depending on your tax bracket. You then invest the borrowed funds in the market, earning "historical average" returns of 10 percent or better.
Surprise! When Joe Homeowner follows this advice the only guaranteed winner is the financial-services industry. Why? Money flows into the market (large sums of it) for investment. Sales quotas are met. Commissions, sales loads and bonuses are generated. That makes Merrill Lynch and Joe’s mortgage banker very happy.
But will Joe be happy? Successfully leveraging home equity into the stock market is predicated on several factors:
• Your home’s value won’t decline for an extended period of time. (It can happen. Look at Japan.)
• The market won’t decline, or trade sideways, for an extended period of time. (It can happen. Tap redial and check with Japan again.)
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