Is it a better investment to borrow home equity to invest in the market, or invest in a rental property?
My husband wants to borrow $50,000 through a home equity loan to invest in some stock that he hopes will earn a 4% return. We have a 15-year mortgage that we are 5 years away from paying off. I know that there are no guarantees with any investment, but the only investment that I'd be willing to borrow against our home for is real estate. We live in a suburb of Seattle where the real estate market is booming. I would like to buy a second home or a duplex to use as rental property. My husband feels like home ownership is a liability, and would prefer to sell our house and rent, rather than own. Is it a good idea to borrow against our home to invest in stock, or should we invest in real estate?
I would advise caution when using debt to purchase an investment. Given your stated rate of 4% for the return it would most likely be severely impacted by the interest you would pay on a home equity loan. It is extremely risky to take out debt to make a stock investment as it's always possible to lose your entire investment. I do wonder why your husband feels home ownership is a liability though. Renting versus buying is one of the ongoing financial questions. You have tradeoffs for both it just depends on which side gives you more of what you want at the best cost both financial and otherwise. Getting into the real estate market, especially a booming one, can also be a risky move. Should the market stagnate or take an unexpected dip you could place yourself at a disadvantage. Also, consider the time and financial investment of having to maintain a second property. These are big decisions that you should consider very carefully before making a move. Make sure that whatever choice you make that you both are on the same page and have the same set of expectations and level of risk you're willing to take on. It might be useful to have a real estate professional get involved to select a property if you decide to invest in real estate and likewise have an investment professional evaluate the stock and weigh that against the cost of the home equity loan. No matter what, keep talking about it with each other. Keep the lines of communication open so that this decision doesn't do any damage to your financial life or otherwise. I hope this helps.
Antowoine Winters, CFP
Next Steps Financial Planning, LLC
I live across the state from you and have done so long enough to see both the "boom" and the "bust" of the Seattle real estate market. Of course, now you are in the midst of a "cosmic boom," of volcanic portions (think, Mount St. Helens). The question then, not only addresses asset classes (i.e. stock or real estate) but timing, comfort, risk, etc.
Though you tried to give a clear view of your finances, you've only created more questions. That said, I would still like to give you some sort of an answer so as to give you some guidance.
Let's start with the basic comparison between investing in stocks and investing in real estate, Which is better? Which is safer? Which one should I hold? The answer, of course, is "yes." As a practice, we advise on our clients' entire asset (household, real estate, retirement, investments, business, stock options, deferred compensation, insurances, exotic animals such as the albino ostrich ... okay, I made that last one up). In other words: we like all of them. However, we also believe that these investments should be aligned so as to support our client's overall goals, goals, comfort, longevity, etc. It is silly, therefore, to argue against real estate as an asset worthy of considering when making an investment.
But that doesn't mean it is the right thing to do. This past week I had a discussion with one of my clients who was considering the sale of his rental property. On our part, we calculated the "total net return" of the property over a period of time (based on a conservative range of the projected increase of his value, rent, holding and sale costs, taxes, etc.). We then compared a "moderate" return on an investment portfolio designed around his goals, risks, etc. The estimated returns/gains were similar enough so as to be within the range of a "wash." After that, we talked about the "lifestyle" issues. Does he like being a landlord? (Not really). Does he like being able to drive past his property, knowing it is paid for? (Not really). The bottom line: we interviewed realtors, helped him negotiate a listing agreement (he was not completely comfortable with this) so that he could list it. We also developed an initial investment plan intended to grow the equity he is now transferring to other investments, including a private placement in ... you guessed it ... real estate! Only with this, his investment will be limited with a favorable loan-to-value, and he won't have the headache of being the owner.
All of that to say, without taking a look at every piece of your investment "pie," I can only tell you that your question should, initially at least, be approached with an honest, open mind as your entire situation is first reviewed. Once done, your answer might be more clear than what you now have.
Give me call if you want to discuss. I am in your "neighborhood" (or at least in Seattle) on a regular basis. Especially with the Mariners now winning!
There’s a lot to unpack here. First let’s figure out all the questions.
Should we invest in local real estate to use as a rental property.
Should we invest in the stock market?
How should we fund these investments?
Should we sell our home and rent?
The only facts that we have is that you are 5 years away from paying off your home, you want at least a 4% return, and 50K seems to be the amount you want to invest.
I’ll start with the should we sell our home and rent question. No, you are only 5 years from paying off your house. If you sell into a hot market, you will probably do well on the selling of your property. But then you must live somewhere. Renting in a hot a market only guarantees that your payments will increase every chance they can.
Now if you stay in your current home, you would like to make some type of investment. You are hoping to get a return of 4%, I assume you mean 4% per year. That’s not a huge number and should be able to be done without significant risk. That could be done with a mostly bond portfolio of investments.
If you go the route of real estate and still want that 4%, it could be more difficult. Finding a property that’s rentable, has low expenses for you, and not a HUGE PAIN is hard to find in any market. There are management companies that can help you, but again that eats into your 4% return that you want.
But the problem I have with all of this is how you want to get the money to invest. Taking a loan to make an investment is a very risky plan. Not only are you going to be paying interest on that loan, but you still owe it if your investment goes belly up. The idea that your investment will pay for the loan is probably not inline with a 4% return in the market. And if you went the real estate route it could take much longer than 5 years left on your mortgage to pay back the HELOC.
You probably don’t want to hear this. But if you want to invest, you can start small and build over time. Starting with a big chunk is nice, but the risk level with how you want to do that is most likely too risky.
Couple things to think about here. You mentioned your husband thinks you should sell you home and rent. If this is on the table that alone should be enough reason to NOT I REPEAT NOT take your home equity and invest it.
There is a lot of risk pulling home equity to invest. If he is picking stocks that he hope will just earn 4% he should get a new investment advisor (or hire one.)
Also there are changes to HELOC (Home Equity Loans) tax deductibility. In this case the mortgage interest will not be deductible which again makes more likely that not an investment strategy you shouldn't partake in.
I'm sympathetic to the idea that home ownership is a risk, but, so is renting. Unless you can easily move every few years, you might have him consider that your landlord would be playing the same 'real estate timing' games that he is, and you'll find many who bought their properties at a low price will be looking to sell as the market rises (meaning you may be moving a lot).
Homeownership provides stability. Yes, there are risks; yes, you have money in an asset that you won't be able to turn into a vacation or food. But, you have stability.
That said... you may not even be in the situation of my hypothetical landlord above if you are buying in at a high. Rental real estate is only a good investment if you have good renters (always a risk) and buy at a very good price.
Not knowing the market in Seattle, if it is like most everywhere else, it is a dangerous time to think about putting your home at risk.
It's always a bad idea to borrow for stock investments. If he is referring to a 4% dividend I would advise researching dividends and stock values in 2008. Most companies slashed their dividend as the price fell.
Just as you would slash rents if home prices fell in another 2008.
I find the idea of finding a good property in a rising rate environment where so many have bid up the prices to new highs to be a difficult idea. If I really wanted to pursue an idea like this I would personally be waiting for the next correction, even if it took 5-10 years. Your buying at a high could take 15-25 years to recover if you can stay above water in the meantime.
If it were me I would set aside the thought of risking your home looking at what the real estate and stock market did over the last few years and role play with a client what would happen if it was 2008, they lost their job, and couldn't afford their rent (or mortgage) and their investment real estate or stocks were now down 50%.