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Don’t Invest Borrowed Money

Posted By Jim On 10/24/2006 @ 12:15 pm In Investing,The Home | 9 Comments

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. [3]

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[3] CNN Money.: http://money.cnn.com/2006/10/16/pf/expert/expert.moneymag.moneymag/index.htm?postversion=2006101613

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