Cashing out home equity to invest
Is a cash-out refinance to invest a good use of your home equity? There are several times it might be:
- A cash-out refinance to fund investments can work if you have enough retirement and emergency funds
- The cash-out refinance to invest in a new business could provide smart emergency cash flow, because by the time you actually need back-up funds, you may not qualify to borrow them
- And cash-out refinancing to buy an investment property may be the cheapest way to get your down payment, closing costs, and other funds
Numbers don’t (usually) lie. Here’s how to determine if cash-out refinancing is the safest and least expensive way to accomplish your goals.
Verify your cash-out refinance eligibility. Start here (Oct 26th, 2021)In this article (Skip to…)
- Cash-out refi to invest
- Pros and good examples
- Cons and bad examples
- Buying an investment property
- The bottom line
Cash-out refinance for investing
Cash-out refinancing simply means replacing the mortgage you already have on your home with a bigger one, and taking the difference in cash. You could use this extra cash to fund your investment.
Keep in mind, a cash-out refinance is still a loan. That means you’re paying interest on the money you withdraw from your home equity.
If you’re sure the rate of return on your investment will be higher than the rate you’re paying on those cash-out funds, this strategy might be worth it.
But if you plan to cash-out refinance and invest the money in volatile stocks — that could potentially lose you money — you’re taking on a lot of risk. Remember that a cash-out refinance is a secured loan. And if you can’t make the payments, your home could be on the line.
Plus, cashing out lowers your home equity. So if you plan to sell any time soon, you’d see a smaller profit on the home sale.
That said, there are times when cash-out refinance to invest makes sense.
Cash-out refinance for stock investing: pros
Using a cash-out refinance to invest in stocks works well for those in a position to take advantage of the pros:
- If your income is solid and expenses low, you’re less vulnerable to stock price drops
- If you’re young, you can more easily ride out the ups and downs of stocks
- The cost of borrowing may be lower if you can deduct your mortgage interest
- The average return on stocks since 1926 is 10 percent, according to Forbes, while mortgage rates are ranging between 3 and 4 percent as of this writing
- You can overcome the problem of extending your repayment if you choose a loan with a shorter term or make additional payments retire your loan on time
- Investing and also paying your mortgage is one way to “force” you into more retirement investing, especially if you direct the money into accounts you can’t easily withdraw from
Your mortgage is what’s called “forced savings.” It pushes you to acquire home equity as you repay your loan. That is often the primary way for less-affluent homeowners to acquire wealth.
Adding that to another form of retirement, like stocks, could improve your future wealth.
Good example of cash-out refinancing to invest in stocks
Let’s say one couple owns a $400,000 home. But they are in their 40s and plan to work another 20 years at least.
This couple owes just $200,000 on a 30-year FHA mortgage, but cannot drop their FHA mortgage insurance, so they are paying 5.5 percent including their mortgage insurance. They also have excellent credit and want to cash out $100,000 from their equity.
A cash-out refinance to invest in stocks might be a good strategy for them.
- They can improve on the terms of their original loan by dumping the monthly MIP premiums
- The amount of cash-out is relatively large, so the added fee is proportionally smaller
- They are in no hurry to leave the workforce and can ride out a bad business cycle
Cash-out refinance for stock investing: cons
For many people, a cash-out refinance to invest in stocks carries risks that might be too high:
- There is no guarantee that investments will increase in value in the short-term. If you need the money soon, you could have to cash out your securities and take a loss
- The cost of cash-out refinancing is higher than rate-and-term refinancing. If you only get a little extra cash, you’re paying a surcharge on the entire loan amount, and that can be an expensive way to borrow
- By refinancing your mortgage, you’re extending the repayment period, and that can cost more over the life of the loan, even if you get a good interest rate
- If you can’t keep up your higher payments, you could end up in foreclosure
Bad example of cash-out refinance to invest in stocks
Imagine another couple in their mid-50s, hoping to retire in about six years. Their home is worth $400,000 and they owe $300,000 against it after 11 years.
This couple has good credit with a representative score of 720. Their current interest rate is 4.25 percent and they want cash out to invest in the U.S. stock market, which historically pays about 10 percent.
They note that refinancing to $320,000 at 4.5 percent drops their payment from $1,970 to $1,620 — but that’s obviously not due to a race decrease (the new rate is higher). It’s because they’re starting their repayment over, and it will add 11 years to their mortgage repayment.
There are many reasons that cash-out refinancing is a bad idea for them.
- The new mortgage rate is higher. They may be able to do better with a 15-year loan if they can afford the higher payments
- The maximum they can likely get with a non-government loan is $320,000, about $20,000 in their pockets after refinancing. That’s not much, considering the cost of obtaining the new loan
- They plan to retire relatively soon. If the market goes south, they have less time to make up their losses
- They added 11 years to their mortgage loan repayment. And 11 years of paying $1,621 a month adds over $200,000 to their costs. Very few $20,000 investments can fill a hole that big
Cash-out refinance to buy an investment property
You can also use cash-out refinancing to purchase a second home or rental property. That means taking enough extra to purchase the whole house, or just to make your down payment and closing costs.
You’ll put the extra cash in your bank or investment accounts, and eventually use it to buy the rental or second home. If you purchase the property outright, the seller won’t care where the money came from. You can just pay and receive title to the home.
But if you need a mortgage to buy the second property, you’ll have to be careful.
Most, if not all, conventional mortgage programs require you to contribute a minimum percentage of your own funds. You don’t get to just borrow your down payment. And government loans don’t let you buy vacation or rental homes.
So any cash-out that you get from a refinance needs to hang around in your bank or investment accounts for a while, until it becomes indistinguishable from your other money. This “seasoning” takes a few months. At that point, you can apply for a loan on the new property, listing all of your account balances as assets.
You’ll also disclose your refinance payment and your other debts in that section of your mortgage application.
The bottom line
Using a cash-out refinance to invest can be smart for the right homeowner — but it’s a tricky strategy to get right.
You want to be absolutely sure that you’re making a smart investment, and that pulling from your home equity is the best way to access the money you need.
Talk to a financial advisor or mortgage professional who can help you evaluate your options. That way, you can be sure you’re making the best move for your overall financial portfolio.
Verify your new rate (Oct 26th, 2021)
