Home Equity
February 20, 2004 10:57 PM   Subscribe

We recently found out we have a boatload of home equity that we wanted to do something with, seems like a waste to have it sitting there. Advice? (more inside)

We've opened a HE line of credit for 120K at a 3.5% rate. (actually, prime minus .50%) We don't really need the money for spending, so what would be some good low-risk places to invest? We figure anything we can earn over 2.7% or so is free money, since our interest on this loan is tax-deductible, there's no fees or costs associated with it, etc. (we pay interest on it for five years, when any balance converts to a regular loan, with P&I payments amortized over the following 15 years.)

We plan on being in this house forever. Our current mortgage is at 7% with about 200K outstanding. We have no other outstanding debt to pay off. Thoughts much appreciated...
posted by luser to Work & Money (19 answers total)
Oh, and we will have college coming up in 7 years, 11 years, and 15 years. We're probably a little behind in saving for that.
posted by luser at 11:08 PM on February 20, 2004

so, you don't actually ever want to own that home, huh?
posted by quonsar at 1:08 AM on February 21, 2004

No, we don't want to own the home. *rolls eyes*

We took out the line with the idea that we could invest in something fairly low on the risk-o-meter, and earn enough to pay the interest plus some more, which would be free money, which we could then spend on hookers, blow and expensive guitars (or on college savings, depending).

The question is, since I haven't been watching investments lately, what's out there that might earn me in excess of around 2.7% or so over a five-year holding period, which would not put the principal at risk? Because we intend to close out the loan at the end of the five years.
posted by luser at 3:56 AM on February 21, 2004

Personally, I probably wouldn't use the credit line to invest elsewhere, unless I had a particularly hot tip (which, unfortunately, we're unlikely to find on AskMe) or if I had no other savings, in which case maybe it makes sense to pay a premium to diversify.

If you do decide to use the home equity to invest elsewhere, make sure the other investment is likely to appreciate if interest rates go up (since your loan payments will rise in this scenario). Bonds, therefore, are probably not a good bet. Stocks are a better bet.

The only investment I know that doesn't put principle at risk and currently pays more than 2.7% are multi-year certificates of deposit. You can probably find a 2- or 3-year CD that pays about 2.7%, and CDs for longer terms will pay more. Technically the principle isn't at risk, however, like bond investments, you could still lose money if interest rates rise. If rates rise, your loan payments could exceed the interest you earn. Since I don't think rates have anywhere to go but up, so I wouldn't recommend CDs. But if you disagree, then CDs might be the investment you're looking for.
posted by blue mustard at 4:21 AM on February 21, 2004

If you could get a higher return with no risk, then so could the bank, and in that case they would just invest the money themselves instead of lending it to you. To get a higher return, you're either going to have to put the principal at risk or make a long-term bet that interest rates won't rise.
posted by fuzz at 5:25 AM on February 21, 2004

A HE line of credit is infact a second mortgage on your home, so you should be careful about running it up too high. If you want to get "free" money out of the equity you should consider refinancing. If the interest rates change, you could find yourself with a nasty surprise.

I also have an Equity line of credit, which we use specifically to improve the house. That way the risk of borrowing against the house is paid off with even more equity when we are done paying it all back than if we bought say... Gigantic plasma screen TVs (hopefully anyway).

Lastly, having too much open credit available to you is bad for your credit rating in some way that I do not understand. If anyone knows why, I would love an explanation of that.
posted by thirteen at 6:15 AM on February 21, 2004

If you want to make money on it, put in the stock market.

You really should seek the advice of a professional financial advisor - it sounds to me like you don't have a whole lot of money saved and that you are new to investing? I would talk to somebody who can take a good look at your whole portfolio.

7% on your primary mortage sounds pretty high to me. Ours is 5.9%, and I'll bet you could do better then that now. Is that on a 30 year fixed? You might consider refinancing at a lower interest rate and looking at something like a 15 year fixed, or an ARM (since you seem comfortable with the idea of variable rate loans and are not strapped for cash.)
posted by drobot at 6:35 AM on February 21, 2004

I'm with drobot. Even with the tax break on mortgage interest, your best payback is likely to be reducing your 1st mortgage. You might be able to go to a 15 year mortgage, which would increase your tax deductible interest and get you mortgage-free sooner.

Your house is a really low-risk asset. Make sure of that by verifying that you have enough insurance on it.
posted by theora55 at 7:42 AM on February 21, 2004

That money is already in the best low risk financial instrument for it: real estate. Paying someone interest in order to add the risk of trying to eke out another couple of fractional points of return is a pretty bad idea. If the equity was "unexpected," that sounds to me like your home's value is up.

Your best bet is to take advantage of that equity by taking steps to reduce the interest you're paying on the mortgage; through refinancing, perhaps. All that interest is dragging down the efficiency of your real estate investment!

Homes in good condition don't get cheaper, they just appreciate at various rates over time. Sit on the equity and enjoy it when you cash out of the house, when it will have an even higher value than it does now.
posted by majick at 8:12 AM on February 21, 2004

If housing prices are going up in your area your home equity isn't "just sitting there." It's appreciating like any other good investment. If I lived anywhere except one of the notorious housing-bubble locations I would leave my home equity alone. (If I did live in a housing-bubble location I wouldn't get a minute's peaceful sleep until I had sold out and moved.)
posted by jfuller at 10:23 AM on February 21, 2004

I'm starting an open source project and could use a patron...
posted by billsaysthis at 10:52 AM on February 21, 2004

My father has his home mortgaged for the third time over, at something under 4% interest. He's had no problems finding investments that pay back far in excess of the mortgage payments, even on an accelerated payback plan, and because the loan is for investment, it qualifies as a (Canadian) tax writeoff/reduction/whatever.

He's made himself a fair bit of money over the years by using his home equity for investment purposes. However, I do believe that's also always been done with a primary mortgage, after the house has been paid off fully.
posted by five fresh fish at 1:03 PM on February 21, 2004

HELOC's are not fixed, right? The rate may be low now, but that doesn't guarentee it will be this time next year.
posted by daver at 1:54 PM on February 21, 2004

fuzz has it right. There's no such thing as an arbitrage. If you could borrow money at a lower rate than you were guaranteed to earn on it, why would the bank lend it to you rather than invest it. Call me hopelessly conservative, but is your home equity really keeping you up at night? I don't get it-- the idea when you "bought" the house was to own it at some point, right? When did credit become the expected stae of affairs?
posted by yerfatma at 2:31 PM on February 21, 2004

What majick and yerfatma said. HE lines of credit are one of the biggest scams going.
posted by adamgreenfield at 6:43 PM on February 21, 2004

William Bennett said it best, "Don't gamble the milk money."
posted by eastlakestandard at 7:42 PM on February 21, 2004

While a 2.9% rate sounds low, and you may think you could make a bundle in the market, what if it tanks. I dont mean the dow going from 10k to 7k. I mean tanks to 5k. With current fiscal policy in the US it could happen. then, you are left with what ammounts to a bunch of uncollectable unsecured debt (Common Stock) and a big ticket to pay on the second mortage.

What you are thinking of doing is exactly what gets a lot of people. Greed. They will think: Why do the safe, smart, long term thing to build wealth when there might be a quick buck i'm missing. Bad plan. Gamble with expendable money, not where you and yours need to live.

Only reason to keep the "line" open is if the interest rate is fixed. Then later if CD's are paying 7% you can screw the bank by borrowing at 3 and lending at 7. Or if you currently have higer fixed rate debt to transfer to the lower fixed rate refi. Better to skip eating out for a year (or two, or however many it takes) and pay it all off though.

However, I'd bet a dollar to a donut that "line" has a floating interest rate tied to prime. Your payments are cheap now, but look out they could accelerate and end up taking your house away if you can't make them. If rates got to 5-8% you'd have a hard time consistenly covering that with any repeatable stock market return.

Pay off your house. Own it free and clear. It will apprecaite if your house is in a good market. if not, sell it and buy one that *is* in a good stable market.

Also, the write off on a house mortage isn't a good reason to not pay it off, according to pretty much every CPA I've met. Paying 50k in interest to save 10k in taxes is a fools game.

Truly wealthy people tend not to finance personal posessions. Cash for cars, Cash for houses, etc. If something has to be financed get it paid off ASAP. Other people prefer the illusion of wealth to the reality and will sell their life away to have the flash. Which one do you want to be?

The secret. Work hard, live below your means, save. Doesnt hurt a bit to learn about investing to make the nest egg grow. Make it grow though, not create it from thin air.
posted by jester69 at 8:18 PM on February 21, 2004

Er, 3.5 not 2.9. Also, he did say it was tied to prime e.g floating. I should have seen that. In that case I wouldn't transfer any fixed rate debt to it. In a year or two you might end up looking at 8-9% interest rates on that one IMHO.

However, I am merely an amateur trying to build a nest egg, so take my advice with a block of salt (salt lick?)
posted by jester69 at 8:28 PM on February 21, 2004

What about using the equity you have in your home to pay the deposit on an investment property? That way, you should be able to rent the investment property for around the cost of the mortgage repayments and, should the rent not cover it, it may be possible to claim a tax loss ( you can do this in Australia, but I don't know about wherever it is you are). The down side, of course, is that you could find yourself paying two mortgages at any times when the property is not tenanted.

In the realm of putting my money where my mouth is, I am planning to do exactly this myself, as soon as local real estate prices come down a bit, as I am betting they will in the next 6 months or so.
posted by dg at 2:52 AM on February 22, 2004

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