Home equity loans for investment
Have you ever considered the possibility of taking out a home equity loan, and putting that money to work in some form of investment? It's not the safest of investment bets, but it might suit you if you're looking for a way to put the equity in your home to work, a way to trade off some security against the financial benefits that can come from sound investment.
How to use a home equity loan for investment
The basic idea of this strategy is simple. First you take out a second mortgage or a home equity loan, borrowing money secured against what you have invested in your home. You can then use this money in any way you like - including investing it. It is possible to invest this money in such a way that your investment will grow enough to be more than capable of paying off the home equity loan, leaving you with a tidy profit.
Now, before you start saying that this is too good to be true, let me explain what's happening here. You aren't making money out of nowhere. You're using the security of your house - which you can think of both as proof that you aren't going to cut and run, and as a way of you putting your own possessions on the line, accepting a burden if things go wrong. This enables you to borrow more cheaply, making it potentially more profitable for you to invest your money. The risk is that your investment doesn't work out as well as hoped, and you end up having to chip in some of your own money to make up the cost of repaying your mortgage. But, nothing ventured nothing gained - by accepting a little risk you have the chance of making good money.
The dead capital argument
Some people talk about home equity that isn't being used for anything as 'dead' - it isn't doing anything for you. That's not entirely true, of course: apart from the fact that you're probably living in your home, the more equity you have, the greater is the security you have. But it's entirely reasonable to want to put this capital to work in the markets.
What about a cash-out mortgage refinance instead
Some people will recommend a slightly different way of achieving the same end. If you already have a mortgage, then instead of taking out a separate home equity loan you can arrange for a 'cash-out' mortgage refinancing. This means that you replace your existing mortgage with one worth more money, and take the difference as a lump sum. I would advise this instead of a home equity loan if - and only if - you are planning to refinance your mortgage in any case.
My reasoning is as follows. A cash-out refinance involves changing the terms for your entire mortgage. This brings the unfortunate consequence that getting a bad deal on that can be very expensive. Choosing a sub-optimal deal on a $5000 home equity loan is a problem, agreed, but choosing the wrong deal on a $200,000 mortgage could mean losing a year's wages over the length of the term. Plus there's the cost of moving a mortgage in administrative charges and lost points - hassle that might be justified if you want a refinance for its own sake, but not if you are really just interested in getting a cash lump sum. So keep refinancing packages to do the job they are best at - improving the conditions of your mortgage - and use home equity loans if you need a cash lump sum.
Will it work?
This is the kind of investment that can never be guaranteed, and as such it isnt't recommended for the fainthearted. Under some investment climates, you will find that it takes massive luck to make enough money out of your investments to pay off the cost of your home equity loan. Under others, you have a chance of making real profits.
Some other ways to invest your home equity
But home equity loans can give you money for anything, not just for playing the markets. They can be used to finance work to improve your home, such as building a conservatory, landscaping your garden, adding an extra bathroom or a swimming pool, or any other work you can imagine. These extensions can be very expensive in the short term - but if you plan to eventually sell you house, you can think of them as investments which just happen to have the side-effect of letting you enjoy living with them. When you sell your home, you would hope to recoup the cost of your home improvement work through the increased selling price of your home. Since home improvement work is so closely tied to your house, it makes obvious sense to finance it with an instrument similar to a mortgage.
Which is the best way to use my home equity loan?
We've now seen two categories of uses for a home equity loan. You could invest it in financial markets, or you could use it for home improvements and extensions. How can you decide which is the better option?
Well, this decision isn't actually as hard as many you'll have to make in your life. Unless you really know the markets, investing your home equity loan in the stock market is a poor option. It might hold out the mirage of higher returns, but more often than not the starry-eyed neophyte investor will return with less than he'd hoped. When you improve your home, you do not need to put so much faith in the invisible hand of market forces. You don't have to try to beat analysts who spend their entire working lives interpreting the markets. You can put your home equity loan in a field that you know better than anyone - making your home a better place to live, and a place that somebody will be willing to pay more money for.
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