Chances are, you’ve built up a lot of equity in your home over the past few years, thanks to rising home values ââand having paid off your mortgage balance. You can tap into that equity in the form of a cash-out mortgage refinance. The money you take out at the close can be used for pretty much anything you want, even investing in the stock market.
The appeal is clear: the basket of stocks that make up the S&P 500 grew by almost 27% in 2021 (the average return on this index has been around 10% per year over long periods), while Mortgage rates were on average 3.28% in the latest Bankrate survey. . The idea is that savvy homeowners can leverage their home equity and reap investment gains that exceed their mortgage interest – and therefore get richer over time.
But that may not be the best use of your withdrawal capital. Investing on Wall Street can be risky, and it can take some time to recoup the costs of refinancing. Carefully weigh the pros and cons and determine if this tactic is right for you and your needs.
Are you allowed to use cash-out refinancing to invest in stocks?
The good news is that you can use the money you take out at the close on a refi for just about anything from financing a home improvement project to paying off high interest debt in courses, including the cost of a wedding or tuition.
âYou are allowed to use your refinance withdrawal money for whatever you want. Typically, people will use the money for repairs and home improvements, but you don’t have to, âsays Nate Tsang, Founder and CEO of WallStreetZen. âJust because the money comes from the value of your home doesn’t mean it should stay there. “
According to Daniel Milan, Managing Partner at Cornerstone Financial Services, there are also no restrictions on refinancing a mortgage if you have built up significant equity in your home and then you go back and invest those funds in the stock market. . in Southfield, Michigan.
âYou just have to refinance with the lender of your choice and then, after receiving the money, you can transfer it to a brokerage account and invest accordingly as you wish,â says Milan.
The advantages of this strategy
As with any financial endeavor, there are pros and cons to pondering. Carefully consider the possible benefits.
âFirst, there are many advantages to financing a stock market investment via cash-out refinancing. You will likely lock in financing at a lower interest rate because the interest rates on secured mortgages are relatively lower than on any unsecured loan, âsays Lyle Solomon, financial expert and senior lawyer at Oak View Law Group. at Rocklin. , California. “Also, the money you get from a withdrawal refi is not taxable because it is not considered income.”
Plus, with a refi withdrawal, you can access your money in a matter of weeks and then start turning it into long-term profit by investing, if your returns are favorable.
âAnd the returns you will see may be greater than the value you would earn on the appreciation of your home if you hadn’t been looking for cash refinancing,â Tsang adds.
The disadvantages of this strategy
The biggest downside to using the cash funds from a mortgage refinance with withdrawal to invest in the stock market is that the stocks, funds, or other investment vehicles you choose can lose value.
âThere is no guarantee that you will get a positive return when you invest in the stock market. You can lose money and still have to pay off the mortgage, âSolomon warns.
Also, closing costs can average 2-5% of your borrowed amount, which can run into the thousands. This can amount to paying a 2-5% charge on a mutual fund, which would be unacceptable to many investors today.
In addition, it can take up to two months to complete a refinance.
âJust by spending that time, the stock market may take a downward turn and no longer look so attractive,â Solomon said.
Plus, you will increase your risk of foreclosure by taking on more debt on your home.
âThis debt has to be repaid with your existing cash flow, and if that cash flow disappears – for example by losing your job – you are more likely to lose your property,â says RJ Weiss, a Geneva-based certified, in Illinois. financial planner and founder of The Ways to Wealth personal finance site. âCombine this scenario with a market downturn and you could end up losing your home and seeing your portfolio fall by 30% or more.â
As if these reasons weren’t enough to avoid this strategy, know that stocks are currently at record valuations.
âIf you were to invest all of your cash refinancing proceeds in the stock market, it is highly likely that you could see a significant drop in your investment if and when there is a market correction,â Weiss says.
Nick Bormann, Investment Adviser Representative and Managing Member of Bormann Wealth Management shares these sentiments.
“For this strategy to work, your stock market return would have to be greater than the additional interest you will pay due to the equity withdrawal from your home and possibly the extension of your mortgage, along with the closing costs involved.” , explains Bormann.
Are you a good candidate for using a withdrawal refi to invest in stocks?
Solomon says you must meet several criteria to be a worthy candidate to invest in the stock market, including:
- Your debt to income ratio should be less than 40%.
- Your credit score must be 700 or higher to get a lower interest rate.
- After cashing in, your home should retain at least 20 percent of equity.
- You earn well, have a reasonable budget, and save a decent amount each month.
- You have the risk tolerance to handle the ups and downs of the stock market.
- You are looking for a long term investment.
- You are saving well for retirement.
âPlus, you need to be able to afford the potential increase in your monthly mortgage payments,â adds Milan. âThose who can’t probably shouldn’t pursue a cash refinance to invest in stocks. “
Instead of putting your home at risk if you default on your loan, a better option might be to invest in the stock market using your savings.
âBy doing this, you are not going to strain your household budget to pay off the mortgage and you will reduce your stress level,â says Solomon.
An alternative approach is to pursue a withdrawal refi but use the cash at close to pay off the high interest debt.
âThen, by using the excess cash flow generated by falling interest rates, maximize your tax-efficient investment accounts while averaging costs in dollars in the market,â Weiss explains.
Or consider refinancing at a lower rate but without collecting equity.
âThen invest the monthly difference between your old payment and your new payment in an investment account,â says Milan.
Regardless of how you plan to pay for your stock market investments, aim to save for retirement first and always make sure you have an emergency fund, advises Solomon.
What to consider before using your cash-out refinancing to invest in stocks
If you are determined to take your money to the stock market, it is essential that you choose the right investments based on several criteria, including your age, when you expect to retire, your tolerance for risk and other factors.
âWhen investing in stocks, mutual funds, or any other chosen investment, be sure to build a strong investment portfolio,â says Solomon, who suggests working with a qualified investment advisor. âI recommend selecting low and high risk investments. By doing so, you can earn high returns and reduce the risk of losing your entire invested amount.