A cash-out mortgage refinance lets you borrow more than you currently owe and keep the difference as cash. It’s one way to unlock the equity in your house. Taking out a Home Equity Line Of Credit (HELOC) is another way.
The most you can borrow from your house is usually an 80% loan-to-value (LTV). In other words, if your home is worth $1,000,000, and you have a $500,000 mortgage, the most you can refinance would be $800,000 and receive $300,000 in cash.
Cash-out Refinance To Buy Stocks
Thanks to the coronavirus, the 10-year bond yield and 30-year bond yield have both fallen to new all-time lows. The 10-year bond yield is now below 1% after the Fed announced a surprise 50 bps Fed Funds cut. As a result, expect more Fed rate cuts to come!
Due to luck, in 2019, we ended up buying a larger house with cash. With a second child on the way, we figured why not buy the house a block away if we could get a good deal. The cash we paid ended up saving us from this hopefully temporary market meltdown.
The question now is whether it would be wise to do a cash-out refinance and pull out lots of equity to invest 100% in the stock market after the correction.
If you are thinking of doing a cash-out refinance to buy stocks, here are some of my pros and cons.
Pros Of A Cash-out Refi To Buy Stocks
1) Lock in massive outperformance. Let’s say the S&P 500 is down 10% for the year and you were to purchase stocks. You would instantly lock in 10% outperformance on your cash-out capital. No matter whether the S&P 500 continues to go down or up, you will always be outperforming.
Although it’s better to always make money when it comes to investing, the next best thing is outperforming the index or your peers. If an active fund manager outperforms his benchmark by 10%, he will be in the top 1% of active fund managers. Given his performance, he’d probably get a record bonus, attract a massive amount of assets, and be given many awards for the year.
To gain true wealth, you must outperform the average, otherwise, you’ll always be just average.
2) Take advantage of all-time low interest rates. The Fed cuts interest rates to spur economic activity. The lower interest rates go, the more people and businesses tend to borrow to buy equipment, property, goods, and services. Doing a cash-out refinance to spend is in a way, following the Fed’s desires.
If inflation is running at 2% and you can get a mortgage rate at 2.375%, your real interest rate is only 0.375%. The lower the real interest rate hurdle, the higher the chance of earning a greater return. From a nominal return basis, the 2.375% mortgage interest rate drag on returns is comparable to paying a traditional wealth manager to manage your wealth or investing in a hedge fund which charges 2% of assets and takes 20% of profits.
Everybody should consider refinancing their mortgage today. But not everybody should be doing a cash-out refinance.
3) Diversify net worth. If you have a large percentage of your net worth in real estate, you may want to do a cash-out refinance to diversify your net worth. Note that your real estate exposure will only decrease based on your increased exposure in stocks. Your absolute real estate exposure won’t decrease since you haven’t sold any properties. You just have more debt.
I’ve got roughly 20% of my net worth in stocks, but I would like to bring the percentage up to 25% if stocks continue to get hammered.
4) You could get a tax deduction. The mortgage interest deduction may be available on a cash-out refinance if the money is used to buy, build or substantially improve your home. In general, homeowners who bought houses after Dec. 15, 2017, can deduct interest on the first $750,000 of the mortgage. Claiming the mortgage interest deduction requires itemizing on your tax return. As always, check with your accountant.
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. Depending on your mortgage rate, your fees will either be baked into your cash-out refinance or you will have to pay fees. Closing costs usually cost between 1% – 4% of your mortgage. If you don’t have a good one, dealing with a bank can be a PITA.
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 1.75% on your cash online nowadays. I’ve never seen the spread between an online savings interest rate and the 10-year bond yield this wide. It’s usually the other way around!
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 fantastic way of quickly losing value, which is why I always encourage folks to practice taking profits to pay for a better life.
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 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.
You do not want to lose money on margin. This is how people lose everything.
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.
4) You complicate your finances and your life. One of the reasons why I’ve never regretted paying off a couple of my mortgages is because each time I paid one off, I was able to simplify my finances. It feels phenomenal to pay off debt. To not have to manage another account is like icing on the cake.
The older and wealthier I get, the more I want to simplify my finances. My goal is to pay off all mortgages by 2027 when my latest 7/1 ARM refinance resets. I’m no longer in the business of trying to take as much leverage as possible to make money. Instead, I’m in the capital preservation stage so I can live as financially stress-free as possible.
Don’t Do A Cash-out Refinance To Buy Stocks
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.
The wisest 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.
I plan to keep life simple and live in our new home without carrying a mortgage. It feels good not having to make any mortgage payments. It also feels good to provide an appropriate amount of shelter for my family. I don’t really care about my house’s value because I plan to own it for decades.
As for stocks, I’ve already used up a majority of my excess cash to buy the ~12% correction. if the S&P 500 corrects by 20% (<2,700), I will start selling my muni bond funds and buy stocks. It’s a decent trade since the muni bond funds will have performed quite nicely in such a scenario.
If the S&P 500 corrects by 30%, I may consider doing a cash-out refinance because that means mortgage rates have gone even lower! Whatever happens, I’ll always be investing some of my monthly cash flow into the market.
Bottom line: Don’t conduct a cash-out refinance to buy stocks. Do always have enough cash on hand to take advantage of random investment opportunities. Do refinance your mortgage when Treasury yields fall to all-time lows. Check out Credible, my favorite mortgage marketplace where prequalified lenders compete for your business. You can get competitive, real quotes in under three minutes for free.
Readers, have any of you ever done a cash-out refinance to buy stocks or other risk assets? If so, how did that go?