“Yes, let’s once again advise American’s (who already have a mortgage) to take out a second mortgage on their rising home equity, and use those funds to speculate in the stock market!!! Have we learned nothing from the 2008 crisis?”, Mike Perry, former Chairman and CEO, IndyMac Bank
Tempted to Put Home Equity to Work?
Tips for homeowners considering a home-equity loan or line of credit to invest in the stock market
By Anya Martin
As home values rise, homeowners tempted to invest their equity in the stock market should answer these two questions:
- What is my tolerance for risk?
- Do I have enough in reserve holdings to cover sudden swings in home values and the market?
Over the past five years, the total return for the S&P 500, including dividends, averages out to 15.45% a year. Meanwhile, average annual interest rates on a home-equity line dropped from 5.41% in 2010 to 5.05% in 2014, according to HSH.com. Given that math, a $100,000 home-equity line held for the past five years would have cost a borrower $25,980, but invested in the S&P 500, that money could have more than doubled to $205,102.
That return sounds like a killer deal, but it has also been during an unusual bull market, says David Blitzer of the Index Committee at McGraw Hill Financial’s S&P Dow Jones Indices unit.
“The last five years were not a typical five years; 2009 was pretty much the end of the recession, the bottom of the bottom,” he adds. “A rule of thumb [for an annual total return] is 6% to 7%, or a double in 10 years.”
Investors need to accept that they could lose money over any given five years in the market, and that money would be borrowed against the equity in their home, Mr. Blitzer says. In other words, if home values plummet, a borrower could be out not only the money invested but owe more than the home is worth, he adds.
Borrowers can dip into home equity either as a line, which can be paid off and then used again, or a loan, which is a set amount at a fixed rate. Home-equity loan rates in 2014 averaged about a point higher at 6.12%, according to Keith Gumbinger, vice president of HSH.com, which tracks mortgage and home-equity product rates.
Most borrowers currently pick a line because of lower rates and the flexibility of potentially paying it off and using the money more than once, says Matt Potere, home-equity product executive for Bank of America , which has the nation’s largest market share in home-equity lending.
Bank of America, like many lenders, offers lower rates for higher loan amounts and lower loan-to-value ratios, which look at the total amount borrowed relative to the value of the home, Mr. Potere says.
Bank of America’s annual home-equity origination volume was up 75% from $6.4 billion in 2013 to $11.2 billion in 2014. Improvement in home values and consumer confidence appear to be the main drivers, with most borrowers using the loan for home improvement, debt consolidation or a one-time large expenditure, such as college tuition, Mr. Potere says. “We really don’t hear much from an investment standpoint.”
While lenders don’t restrict how a borrower may use their home equity, borrowers also should consider tax implications, says Eric L. Green, a partner with Stamford, Conn.-based law firm Green and Sklarz, which specializes in tax matters. Yes, borrowers could deduct up to $100,000 of interest on a home-equity loan, but any investment growth will be subject to capital-gains taxes, he adds.
On the plus side, a “long-term” investment of more than one year would qualify for lower tax rates on dividends and capital-gains tax rates. Tax rates are 20% for investors in the highest 39.6% income-tax bracket, 15% for investors in the 25% to 35% brackets, and zero for those in the 15% lowest bracket.
In the best-case scenario, borrowers who want to invest home equity in the stock market should have the flexibility to either sell their investment sooner or hold it longer if market conditions get rocky, Mr. Blitzer says. In other words, it may be more risky for homeowners who know they are likely to move or sell the house within five years, he adds.
“Typically the stock market goes up and down faster and is more volatile than the housing market, even including the [recent] boom and bust,” Mr. Blitzer says. “If you wait long enough, you are probably going to come out ahead in the stock market, but there are certainly some cases where five years are not long enough.”
Here are a few more tips for anyone contemplating a home-equity line or loan:
- Fees differ among lenders. Borrowers who shop around may save. Some lenders charge no fees for their home-equity products while others may charge closing costs, third-party origination fees, mortgage taxes and annual fees, Mr. Potere says.
- Relationships may matter. Conversely some banks offer discounts to customers who already have other accounts.
For example, Bank of America Preferred Rewards members may save up to 0.375% on a home-equity-line interest rate.
- Don’t forget AMT. Taxpayers subject to the alternate minimum tax need to keep in mind that they won’t be able to deduct home-equity interest.