Mortgage interest rates are still hovering near all-time low levels after a few rate decreases from the Federal Reserve. The big banks are eager to lend money, but they’ve raised their lending standards since the banking crisis of 2007-2009.
After a period of real estate appreciation like we’ve seen over the past decade, home equity loans become more available to more people.
Here’s a chart of homeowner equity (mobile, turn phone horizontal for best experience):
The ideal use of a home equity loan is for home improvement that increases the value of the property by more than the borrowed amount.
But home improvement is not the required use. When you borrow from a HELOC, you just transfer the money to your checking account and do what you want.
You can even use a home equity loan or line of credit to invest.
Generally speaking, I don’t recommend using a home equity loan to invest for most people. It’s risky to put your house on the line to chase returns. It’s better to save up cash and invest.
But that’s a conservative stance. Money management that’s too conservative can prevent us from getting rich.
If you’re an experienced investor, it may make sense to unlock home equity under certain circumstances.
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 (Wells Fargo) 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 I’ve learned from the experience.
Back then, I wanted to have access to our home equity if ever needed, but we didn’t 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 (since paid off), 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 don’t need.
It’s 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, I’ve asked myself many times, would it be smart to borrow money against my house using our HELOC and invest the loan into something else?
I’ve 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 don’t think I’d ever deliberately borrow against my house to invest in stocks. But I might consider profitable real estate opportunities.
Or maybe even borrow money to purchase alternative investments? Those are not risks I’m willing to take. But my risk tolerance is low. Such investments might pay off over decades.
When I first wrote this article in August 2015, I was thinking about borrowing to invest in Lending Club notes when the returns were still good. Those gains didn’t last, and I’m grateful I kept to my instincts and didn’t borrow from my HELCO to invest.
But there are many different ways to look at this dilemma, so let’s dig in.
Personal Finance is not Black and White
People tend to prefer answers in black and white. But in personal finance, there’s rarely one way to answer a question. The answer depends on the situation of the individual or family.
As someone who has always had a reasonably low-risk tolerance, it seems like a risky idea to borrow to invest. My equity is safely parked in my home, keeping the mortgage payment low. If I pay extra on the mortgage, I should be able to retire without one in 12 years.
But another part of me thinks, well, if I can make 8% lending to real estate investors, or 10+% returns making direct investments in commercial real estate, why wouldn’t I borrow at 3% to invest? I could be like a bank and make a nice spread.
Or I could borrow at 3% and buy AT&T, which often yields 6%, plus price appreciation and annual dividend increases.
I’d earn a 3% spread with low risk, plus the potential to make more. Not bad, right?
Or why not get a home equity loan on my primary residence and buy another rental property?
Well, the additional risk would probably keep me up at night, and worst-case scenario, an investment could go sour.
What this comes down to is the age-old question of become debt-free or leverage up and invest to build wealth.
This argument is personified in the fundamental beliefs of financial pundits Dave Ramsey (become completely debt-free, then growth wealth) and Robert Kiyosaki (use debt to become wealthy).
I can’t say I’m a disciple of either, but both philosophies are valid and work for different people.
Dave’s philosophy is very conservative and low-risk. By following his simple methods and lifestyle, individuals will go through their financial life with minimal risk involved, and will eventually become financially wealthy over time.
Robert’s philosophy is all about taking on more risk by borrowing money to invest, usually in real estate. Doing so will make individuals wealthy faster, though more susceptible to macroeconomic turmoil.
The wealthier I become, the more I think Kiyosaki’s philosophy is the better method for attaining greater wealth. At the same time, Dave’s approach is probably best for most people who don’t pay enough attention to their finances.
Often forgotten, there’s a middle ground, which is where I usually end up.
Everyone should deploy a strategy that works for them, and not succumb to envy or end up swimming naked when the tide rolls out.
Part of the reason why the rich continue to get richer, is they are willing to take on more risk to make more money. But the rich can afford the risk. If something goes wrong, they aren’t out on the street. They have the capital elsewhere to support themselves.
Our family becomes more financially secure every day. We’re at the point we can comfortably and conservatively take on more risk. Even if things in the markets turn ugly again, or I lose my job, our house will not be at risk.
We have enough assets in cash, stocks, and retirement investments to guarantee that won’t happen, as long as we don’t buy a bigger house or make a bad investment with borrowed money.
Looking at the Question Wearing Different Financial Hats
Over the years, I’ve read a lot of books and blogs of pundits with strong beliefs. I’ve 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, I’ll put on my pragmatist hat…
If you have a home and a mortgage, and invest, you are already borrowing against it to invest.
Homeowners with a mortgage are already borrowing against their homes to invest.
How’s that, you say? Well, you’re already using leverage (a mortgage loan secured against your home) to free up cash to do other things.
A mortgage allows a homeowner to make a big purchase and spread out the payments over time. The price to do this is the interest you pay.
If you borrowed more against your home in addition to the mortgage, it’s the same thing. The only difference is the bank obligation would increase.
Put another way, let’s say someone owns a home with 30% of the home’s value in equity, and 70% of value in a mortgage. They bought the home with a 20% down payment, and over time the equity increased through appreciation and principal payments.
If they were to borrow 10% against the present value of the home, the equity would go back to 20%, the same as when they bought the house. At today’s rates, it may be possible to get a lower rate than the original mortgage.
A second payment increases overall risk, but not substantially so. The homeowner now has more money for profitable investments.
Next, I’ll put on my conservative financial pundit hat…
Using home equity to invest is a terrible idea, period.
Maybe this is the first thing that came to your mind. It’s 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 don’t 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. They’re 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…
It depends on how you invest it.
I know plenty of people who have borrowed against their own homes to buy an investment property. Flippers do this all the time for short-term investments.
Entrepreneurs often take second loans on their homes to start businesses.
Borrowing to buy stocks through a margin account is common. So inevitably, some individual investors take out a home equity loan to invest in stocks at times.
Sounds like a ticket for bankruptcy if done carelessly, but what about for conservative dividend growth investors?
Or what about using a home equity loan to pay for education? Is that a harmful or risky investment? It depends on the degree and student, but the return on investment from education is one of the highest over the long-term.
Taking big risks means big rewards. It’s all about how much risk you’re willing to take to accomplish your goals.
Borrowing money from one property (your home) to buy an investment property, is broadly acceptable.
Take the classic (and hereby simplified) real estate investing example, using two different investor approaches. Investor #1 has $100,000 and pays cash for a rental property of the same value. He’ll make good cash flow on the property since he isn’t paying a mortgage, and over time the property will appreciate.
This is a safe investment that would cash flow nicely. Assuming a 3% appreciation rate on the property, it would be worth $243,000 in 30 years.
Investors #2 takes the same $100,000 and buys four investment properties, each worth $100,000. She puts 25% down on each one. Each property cash flows positively, collectively about the same profit as Investor #1. Over time, however, she has four properties that will appreciate.
Assuming the same 3% appreciation, the combined value of all four properties after 30 years is $972,000. She’ll have paid about $329,000 of interest over 30 years (assuming 4.5% rate).
Note: This example, for simplicity sake, assumes the net positive cash flow of the paid off property of Investor #1 ($800, for example) equals the net positive cash flow of the four properties of Investor #2 combined ($200 x 4).
There are also significant tax benefits to real estate investing.
While riskier, Investor #2 would end up with more wealth over time. That’s the power of leveraging up in real estate.
Buying stocks would be different since there isn’t a hard asset at hand. The quality of the stock investment would be supreme, perhaps too important to take the risk in the first place.
Return spreads would likely be lower than real estate, and taking the risk with individual stocks is not as predictable and thus riskier. Taking out the max and going all-in to the market is not a good idea.
What about investing in a business or education? Both could be excellent uses for the money. It all depends on perspective and comfort with risk.
Lastly, my Rich Dad Poor Dad hat…
Done smartly, investing using a home equity loan against your home will make you rich.
I’ve seen several interviews on CNBC and Business Insider that ask wealthy people how they became rich. They’ll often say because of leverage. They’ve used other people’s money (e.g., the bank’s) to make investments that made them money above and beyond the cost of the money.
This is the core of Robert Kiyosaki’s methodology. Treat your finances as if you are a business, utilizing capital in the best way you can. Use leverage when the numbers work, and take on more risk to become wealthy.
This is not an easy path. There will undoubtedly be more ups and downs along the way. The easy route is the conservative one, to pay off debts and get rich at a snail’s pace, safely and avoiding volatility.
Perhaps the wealthier you are, the more this thinking resonates with you. Wealthy people can take more significant risks because they have a foundation on which to fall back on. When you crunch the numbers, the math will tell you that borrowing at 2-5% against your home to invest could be highly lucrative over long periods.
Surely some options traders out there borrowed a ton of money at some point and are now fabulously wealthy. It’s likely a larger number of people tried options trading on loan and went broke.
And we know from watching Shark Tank, that entrepreneurs borrow money in all kinds of ways to try to make it big. Some succeed. Many fail.
Six Years Later
Temptation is a powerful force. I’m tempted almost daily, passing by a doughnut shop near my workplace. Most days, I pass. Occasionally, I stop and buy a few.
When I first wrote this article five years ago, I was tempted to borrow to invest. It may have made me wealthier if I had.
But I’m glad I didn’t.
Today, after the sale of my rental condo, I’m flush with cash. I’m quite comfortable here, knowing that our lifestyle is secure. I also have the option to find the right opportunity to make a strategic investment should it come my way.
We can afford to take more risks. But today we’re in a position to take risks with cash instead of leverage.
Maybe I’ll consider more seriously a new investment property using the saved up cash. Or we’ll use the extra cash to upgrade our home. But I don’t ever see us tapping our HELOC to invest.
The wealthier our family has become, the more it makes sense to take greater risks to produce more cash flow and asset appreciation. If we don’t, it may continue to be an opportunity lost.
But I sleep very well at night knowing I have cash in the bank and a vehicle to tap home equity if it’s ever needed. But not for investing.
Update: We refinanced our mortgage to a 20-year, 2.75% interest rate loan in September 2020. Refinancing meant we had to close our home equity loan/line of credit.
We don’t need the access at this point. If in the future we want to use a HELOC to invest or for other uses, I’ll likely look to an online lender such as Credible* or Figure, which make the process simple.
Disclosure: Long T
Have you ever used a home equity loan to invest in real estate or other assets?
Featured photo by John via PureIMG free stock photos
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