Don’t Bet the House! (You May Lose …)

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12/7/2005, 6:30 am

It may be tempting to borrow against the equity you have in your home in a cash-out refi and then use that borrowed money to invest in the stock market. Generally, it’s not a good idea because of the risks involved; the ultimate risk being that you lose your home.

While a rare few may get lucky and hit the big time, the majority of folks are only adequate stock pickers. And it usually takes better than adequate to earn a return to cover borrowed money.

That’s really what a cash-out refi is: borrowed money. By using your home’s equity to invest, you’re actually investing with borrowed money and paying interest on the money you borrowed. Paying 5% interest on money you borrow in a cash-out refi means you must earn 5% more on your investment to cover your interest. (Your tax situation may change this slightly.)

It’s best to avoid thinking of the equity you have in your home as if it’s free money or a savings account. It’s not. When you pull your equity out, you’re actually borrowing money and using your home’s value as the collateral for the loan.

Any investment that goes bad is painful. A bad investment made with your home’s equity is twice as painful. If you can’t repay the loan because you lost it “investing”, you also lose your collateral to the lender.

This is a classic example of the truth in the cliche, “A bird in the hand is worth two in the bush.”

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