Negatives Of A Cash-out Refinance To Buy Stocks
1) Refinancing takes time and money. It takes between 1 – 4 months to do a cash-out refinance, on the longer side now with many banks completely working remotely and increased numeber of applications with current lower rates. Depending on your mortgage rate, your fees will either be added into your cash-out refinance or you will have to pay fees. Closing costs usually cost between 1% – 4% of your mortgage.
By the time you’ve got your cash, the stock market may have moved up to the point where it is no longer attractive to buy. If you don’t use the cash, you’ll then end up with a cash drag. Fortunately, you can still earn a decent 1.25-1.75% on your cash online nowadays.
2) You could lose money. As we all know, there are no guarantees when it comes to investing in stocks or any risk assets. Stocks have a way of quickly losing value, which is why I always encourage folks to practice taking profits when the opprotunity rises.
I could lock in a 10% outperformance, but if I lose 10% on let’s say $1,000,000 from a cash-out refi, I’m not going to be very happy. I would have rather kept the $1,000,000 locked in the house and have it outperform by 20% without doing anything. Even if I were to make 10% with a stock rebound, making $100,000 may not bring me much joy.
3) Increase foreclosure risk. If you end up losing a ton of money in the stock market after your cash-out refinance, you might reach a point where you are no longer able to pay your mortgage. Because your home is the collateral for any kind of mortgage, you risk losing it if you can’t make the payments. A key here is knowing your personal risk profile and where you are in relation to retirement. Someone say less than 5 years out shouldnt go out of their way to add on more and more leverage to place in stocks which are known to be volatile in the short term.
4) Can complicate your finances and your life. One of the reasons why I don’t regret paying off a couple of my mortgages is because each time I paid one off, it greatly simlified my finances. Sure those math wizards will tell you you’re leaving money on the table or arent maximizing your ROI, but it feels amazing to pay off debt. To not have to manage another account is like icing on the cake.
A Cash-out Refinance To Buy Stocks is not for the risk averse.
Conducting a cash-out refinance to buy stocks is a suboptimal financial move. Yes, stocks tend to provide an 8% – 10% annual return over the long run, but you could face a negative sequence of returns after your purchase.
If you absolutely want to use some of your home equity to buy stocks, then I would wait until there is at least a 30% correction in the S&P 500. I use 30% as a benchmark because the average bear market since World War II has seen a 32% decline. Therefore, if you buy stocks with your home equity after a 30% decline and can hold on for at least a year, you will probably make money based on history.
Just make sure that if you plan to do a cash-out refinance to buy stocks that you also have enough liquidity to survive. When stocks are down 30% or more, the economy is down in the dumps. During this time, you might lose your job and your other investments may also lose lots of value.
One smart thing you can do with your cash-out refinance is to pay off higher interest rate debt, if any. Given the average credit card interest rate is still a whopping 17%, your guaranteed return is probably greater than the average return in the stock market.
While I will not be cash out refinancing to buy stocks, the current combination of low interest rates and a depressed market can be very tempting for investors with ample equity in real estate. I plan to continue trying to refi most of my rentals and whatever happens, I’ll continue investing some of my monthly cash flow into the market.
Bottom line: Don’t conduct a cash-out refinance to buy stocks if you don’t have reserves for if things temporarily go south. Always have enough cash on hand to take advantage of random investment opportunities. Refinance your mortgage when Treasury yields fall to all-time lows.
My little buddy Zeus says do what makes you happy.