Don't Bet the House on a Market Recovery

Taking equity out of your home for investment purposes is a risky proposition.
By Peter McDougall ,

With stocks down (the Standard & Poor's 500-stock index is about 11.2% lower since Oct. 1 of last year) and loan rates below 6%, some bold and opportunistic investors may feel tempted to dip into their home equity in order to invest in the stock market.

After all, many folks

agree

that the stock market does well recovering from a recession.

But what if the return on your investment isn't enough to cover the cost of the mortgage or home equity loan? In that case, you will lose money -- and you could even lose your home.

Most Americans at one time or another have borrowed money in order to buy an asset. A mortgage is a straightforward example of this type of investing, where you borrow money from a lender to make a low-risk investment in a home.

But you can't just go out and buy any house; regulations exist to prevent people from borrowing more than they should. (Blurring these rules resulted in the current subprime mortgage mess.)

With stocks, however, there is nothing to stop you as an individual from taking equity out of a home and investing it in securities -- except, perhaps, good sense.

The National Association of Securities Dealers (now the

Financial Industry Regulatory Authority

) issued a warning to its regulated firms back in 2004 that it was becoming increasingly concerned about homeowners using home equity to buy securities. It cited low interest rates, expected growth in the market and high home prices as key contributors to the growing trend.

Two of those three conditions apply today: Home prices are down, but we are in a period of low interest rates and many argue the market is ready for a recovery.

But while the stock market is a proven performer in the long term, there are plenty of ups and downs along the way. You must be able to ride out the inevitable downturns in the market if you want to reap the full benefits of a diversified investment portfolio. This is hard to do if you are relying on your investment to pay for your monthly loan obligations.

What's more, your investment returns have to cover your borrowing costs before you can make a profit -- and that's not easy to do.

Imagine this scenario: You only have some equity in your home, but you find yourself a little strapped for extra cash. The stock market is poised for a big rally (or so you have heard), and you decide that putting a little of that hard-earned home equity to work in the market is a good idea. You refinance at today's low rates, and take out an extra $100,000 in cash.

Now let's say that you buy stock with that $100,000. You'll need to earn enough to pay your interest on the loan just to break even. And what if the market heads south instead of rallying? If you were depending on pulling money out of your flourishing portfolio to make your monthly payments, you might have a problem.

So unless you have reserve funds that can cover the added loan obligations, the risks associated with using equity to buy stocks are just too high.

When you invest in the market with spare cash, you only stand to lose the principal if that investment goes bust. If you invest money that you borrow using your home as collateral, you stand to lose both the borrowed money and your home.

Peter McDougall is a free-lance financial reporter in Freeport, Me.

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