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Don’t Invest Borrowed Money
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Technically, it’s not borrowed money, but in this week’s column Walter Updegrave writes about how you shouldn’t “borrow” against your home’s equity and invest the money. Now, you would think that it’s not that bad of an idea because you’re not really borrowing money from someone else, you’re just selling your garage and investing the money, right? Well, the big deal is in the mechanics because in order for you to cash out that money, you will likely have to use a home equity line of credit (or you could refinance, but that’s far more expensive) that will have something in the range of 9% (6%+ considering the tax implications), so you will need to be on the better side of 6% in your investment decisions to come out ahead.
When you are investing, you typically want your decisions to buy or sell to be driven by the market itself, not outside factors. Anytime your decisions are guided by non-market related factors, you’re put into a bad position. For example, if you want to sell Ford because of their recent earnings announcement, that’s fine. However, if you don’t want to sell Ford but you have to sell Ford because you need the money to pay off a mortgage payment – you’re in a bad spot. This will apply whether the source of the funds is a loan from a bank or a “loan” from your emergency fund.
Getting back to Updegrave’s article, the pitfalls of borrowing from a HELOC has to do with the fact that it’s a variable rate (ouch!) and that you have no guarantee you’ll be on the plus side of the arbitrage play. HELOC rates are around 8%, or 6% after the tax deductibility factor of the interest payments, so you’ll have to be on the plus side of at least 6%… that’s a lot of pressure especially when you consider the goal posts are going to be moved back from time to time.
Walter finishes up the article by putting things into perspective. It’s like 0% balance transfer arbitrage plays, except nothing is for certain and you’re taking a lot of risk for not that much return. At least with the 0% balance transfer arbitrage plays, your borrowing rate is fixed and your earnings rate is relatively fixed – neither is the case with borrowing on a HELOC to invest in the stock market.
via CNN Money.
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yes definitely I would not recommend investing borrowed money. People can get emotional enough with just regular money.
Actually, you need to come out well north of 6% since you have to pay taxes on the income you gain. Witness: borrow $1000 via equity line, invest for a year. Pay $90 in interest. Earn $90 in returns. Claim $90 as an itemized deduction, but your “income” is increased $90. So you actually net nothing. Did I miss something?
Out of curiosity, does the article specifically mention 0% BTs? That seems to be the most common form of “investing borrowed money” and it seems pretty safe (if you trust yourself). I do it myself. I recognize the risks, but my greedy little hands do it anyway. =) But I was curious if the article mentioned pro’s or con’s of 0% BTs as opposed to loans…
It didn’t mention 0% BT’s, the article was about a guy who wanted to take out a HELOC and invest the money.
It should be noted that it’s extremely difficult to get outside financing for a small business unless one has borrowed substantially against one’s own house first. Investors perceive the decision not to take out a HELOC as a sign of lack of commitment.
I’d never pull money out of the house to play the stock market. But if my business ever needs more capital than I’ve got lying around, I’m not going to hesitate to do it for that.
Carnival of Investing #46
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I realize that the post is a US view, but I would like to make a Canadian view of investing with a HELOC. In Canada, mortgage interest is NOT deductable. So, by paying down the non deductible mortgage, and investing with the increasing credit limit HELOC, you can make your mortgage interest deductible! We call it the Smith Manoeuvre. Not only that, Canadian HELOC rates vary with prime which is aroudn 6% right now. So if you are in the highest marginal tax bracket, you’re looking at around 4% interest after the tax deduction. Combine that with investing in stable Canadian dividend stocks, you have a long term plan to financial wealth.
Joe
http://www.StingyFinance.com