Using a home equity loan to invest can sometimes be advantageous, but it's not something you should enter into lightly.
What Is a Home Equity Loan?
Home equity is a person's financial stake in his or her home. A home equity loan allows you to borrow up to 125 percent of the appraised value of your home, less any existing mortgages. Consumers generally take out home equity loans for shorter periods than their original mortgages (five to 15 years versus 25 or 30).
Home equity loans have become increasingly popular in recent years. Low interest rates (typically higher than first mortgages, but not as high as other borrowing options) and the interest deduction are two reasons for this, but you should consult a tax advisor for the tax implications in your situation.
Lumps Versus Lines
There are two types of home equity loans: term (or closed-end) loans and lines of credit (open-end loans). The former is a one-time lump sum paid off over a predetermined time period, at a predetermined rate of interest. A home equity line of credit (HELOC) sets a maximum amount for the line and lets the borrower withdraw money up to that point, as he or she needs it. There are minimum requirements for paying back the principal -- both in terms of time and amount -- but the borrower can overpay (and then dip back in up to the maximum again). The interest rate on a HELOC is usually variable.
Is It Wise to Use a Home Equity Loan to Invest in Securities?
Not necessarily. But, if you are financially stable, are not reliant on investment returns to cover your mortgage payments and are a knowledgeable investor, the home-equity gamble might be a way to secure low-interest money to use to invest in securities. Otherwise, it could be too much of a risk.
The risk is this: When you buy securities with mortgage money, the funds with which you're investing are not your own. Mortgage-money investments that go sour take the collateral supporting the loan -- the house -- down with them. That's a sad ending for the equity you spent your adult lifetime amassing. There are other options available if you want to borrow money to invest in stocks, and they don't involve the risk of losing your home. Talk with your financial advisor to find out more.
Indeed, the NASD (the National Association of Securities Dealers), the world's largest private-sector securities regulator, is so concerned with the practice that it is taking "enforcement actions" against brokerage firms that recommend this source of funds for consumers looking to invest.
If you're still game, you need to look at the specifics on both sides of the transfer. For example, if the interest rate on your home equity loan is four percent, you'll want to make sure the investment you're moving to promises a return that's at least a couple of points higher. If you've got your eye on growth stocks, remember that growth stocks offer no guarantee of growth. Government-insured programs, while not offering the same potential for returns, might be a safer bet.
Before making any investment decision, it's wise to discuss the specifics of your own situation with a financial advisor.
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