If you owned your house outright, but were offered a cash-out refi under 2%, would you take the money, and invest it in stocks instead?
With mortgage rates still near record lows (some 15-year rates are near 2% and 30-year rates below 3%, as you can see here) and stocks performing solidly, this question from a reader of MarketWatch Picks intrigued us:
“I’m 60, retired and debt-free, including my South Florida condominium. I’ve received an offer for a 15-year mortgage at 1.75%. I’m making significantly more than that in my investment account. I’m considering refinancing, taking some cash out and investing that money. My investment advisor is firmly against the idea. He doesn’t want me to take on debt and thinks I should preserve my equity in case I need it later in retirement. Who’s right?”
We asked financial planners their thoughts on that question, and whether others with substantial home equity might want to consider a similar move. Here’s the verdict. Yes, it’s true that mortgage refi rates are near historic lows, and those with excellent credit scores may be able to find refi rates around 2% right now. And your investments could easily earn more than 2%: As of the end of October, the Standard & Poor’s 500 Index is up more than 21% for the year.
But while the return on even a low-cost ETF might easily top 2%, there’s more than just the interest rate involved here. That’s because you’d also be repaying the loan principal along with that low-rate interest.
Example: You get $50,000 from a cash-out refinancing and invest it in an ETF that tracks the Standard & Poor’s 500 index, producing a 20% gain for the year. (Note that the average return since the mid-1950s was between 7% and 8%.) That’s a tidy gross return of $10,000. However:
- The payment on the new $50,000 mortgage at 1.75% is $316.03 per month, a total of $3,792 for a year;
- You’ll have one-time closing costs on your refi or home equity loan. Typically, that’s 3% of the loan balance, or $1,500 in your case;
- Now your net profit is cut to about 9% — and that doesn’t include the trading costs and taxes on your investments.
Still, you’ve made $4,708 in the first year, which is a nice chunk of change.
That won’t happen every year, warns Greg McBride, chief financial analyst for Bankrate.com. If the $50,000 you invest returns 7% for one year, you’ll make $3,500. That means your investment produces $300 less than you’ll pay on the new mortgage in a year. But, thanks to the magic of compounding, you’ll still make money over time. That’s because $50,000 invested at an annual return of 7% will generate nearly $88,000 in returns over 15 years. Even if you withdraw the money for the mortgage payment at the beginning of each month, you’d still come out at the end of 15 years with a profit of more than $39,000.
“For the savvy investor who thinks long-term, the rate of return possibilities can pay off handsomely with such a low borrowing cost,” McBride said. “But we’re talking about buying an S&P 500 or total market index that can go on for decades. This is not a strategy for day-trading or investing in some meme stock.”
Another consideration is your ability to stay current on your new mortgage without touching any of the money you invest. You also should consider how investing home equity fits into your overall financial plans, said Scott Smith, a certified financial planner and senior advisor at Lifecycle Financial Planners in Bloomfield Hills, Michigan.
“I don’t recommend taking the entire 80% of equity that can be borrowed but if it was 40% to 50% of the equity — especially since he can pay the loan off if he needs to — I would likely recommend that,” Smith said. “We recommend that to clients frequently.”
Typically, financial planners advise using home equity loans to finance home improvements or to pay down credit-card balances or other high-rate debt, but you don’t have those issues. In the end, your own planner will be the most familiar with your finances and likely knows best.
