Use a HELOC to Invest In the Stock Market
Using borrowed money, like from a HELOC, to invest in the stock market has to be one of the dumbest ideas I’ve ever heard. But, taken to its logical extreme, the advice commonly given to not pay off your mortgage early would have you do just that.
So maybe I should take my bank up on their offer:
(click to enlarge image)
Like I’ve pointed out a couple of times before, I believe strongly in paying off a mortgage as soon as is reasonable. By that I mean sending extra money each month toward principal curtailment or any of the other methods I’ve written about.
There’s a contrary school of thought that says you should not prepay your mortgage and instead invest that money into a low-fee index fund. The reasoning being you’ll get a better return in the stock market than you’re equivalent return based on your mortgage rate. Liz Pulliam Weston, Ric Edelman, and Walter Updegrave are all adherents to the ‘invest instead of pre-pay’ school.
Borrowing to invest
But taking that line of thinking to its logical conclusion, it would be a good idea to borrow additional money against your home (in the form of a HELOC, cash-out refi, or second mortgage) and put it to work in the stock market. Call me risk averse, but that’s insane. I actually had a friend do just that and he got smoked when the market dropped in 2000.
What people forget is that pre-paying your mortgage is a guaranteed return. Ok, maybe it’s only a guaranteed 6% return, but it’s a sure thing. The historical return on the S&P 500 is 10.4% (thanks MossySF). The mathematically savvy reader will note that 10.4% is greater than 6%. That 4.4% can be thought of as your risk premium. But for me personally, I’ll pay that 4.4% per year in exchange for having no mortgage payment.
One other quick thing. While in an emergency I can suspend my principal curtailment payments, you can’t do that with a HELOC payment. It sure would suck having to write a check each month to repay a loan while simultaneously watching a bear market destroy your portfolio.
Think I’ll stick with my 6% return.
mortgage
July 18th, 2007 at 9:56 am
Hello. I agree and I have another article of my own in the works as part of a series on housing myths. The arbitrage argument has some merit but often is inconsistent and muddied with bad math.
July 23rd, 2007 at 4:51 pm
August 2nd, 2007 at 1:09 pm
Don’t forget that you need to pay interest for borrowed money and taxes on gain, so assuming that interest is even 3% (which is pretty low) and taxes are 30%, you come up with (10.4% - 3%) * 70% = 5% gain.
March 27th, 2008 at 4:37 pm
“What people forget is that pre-paying your mortgage is a guaranteed return. Ok, maybe it’s only a guaranteed 6% return, but it’s a sure thing.”
Also, remember that there is a front end interest load on a mortgage amortization schedule. That 6% interest rate occurs on the last payment of a 30 year mortgage. The interest-to-principal ratio ranges from 6.0 to 2.2 over the course of the loan.
What this means is that the *guaranteed* return is far higher than 6%!