Should You Use a Cash-Out Refinance To Invest in Stocks or Crypto?
A homeowner, let’s call him Mr. Jones, cashes out his home to the tune of $100,000. He invests 50% in the stock market and 50% in crypto.
The economy gets rocky—his home value drops. The stock and crypto markets fall 25%. He also loses his job.
Mr. Jones is now underwater on his home, can’t make the payment, and can’t sell. He drains the initial investment, now worth only $75,000. When that runs out, he gets foreclosed on.
If this story makes you uncomfortable, then it’s probably a bad idea for you to use a cash-out refinance to invest.
The story may sound unlikely. But it takes just a small change to the economy to trigger a series of unfortunate events that are intensified by unnecessary borrowing.
Here are the risks if you’re still considering this strategy.
Your Home Equity Could Vanish
It’s not uncommon for certain funds – like S&P 500 funds – to lose 10% or 20% of their value.
Individual stocks can incur even more drastic losses. Peloton, once a hot COVID-era stock, is down 96% from its highs at the time of this writing.
Many cryptocurrencies fared about the same.
While untapped home equity isn’t necessarily working for you, at least it’s safer locked up in the house than subject to the whims of the market.
It Will Be Harder to Sell if You Need To
Cashing out your home could make it hard to sell. Over-leveraged homes require cash from the owner to pay for agent fees, title costs, and transfer taxes. It costs about 10% of a home’s entire value to sell.
If you lose the equity in your home, can’t pay to sell, and can’t make the payment, there’s no option but foreclosure.
Borrowing Home Equity is a Guaranteed Cost Without Guaranteed Gain
If you cash out $100,000 at 7%, you’ll pay $7,000 per year in interest. (By the way, it’s not tax deductible since the funds didn’t go toward improving the home.)
So you have to make $7,000 per year from your investments just to break even.
What if rates go lower? If rates drop, it’s a good indication that the economy is entering a recession. That’s an even worse time to be investing in stocks and crypto.
And, even at lower interest rates, you’re not likely to make more than it costs to borrow without putting the money at significant risk.
You Get Taxed on Gains
If you do incredibly well, you’ll get taxed on earnings. This makes it even harder to break even on interest paid.
Those who employ this strategy should use cash-out refinance proceeds to fund retirement accounts that do not require taxes on earnings, such as a ROTH IRA.
There’s more to lose than to gain when investing in a taxable investment account with borrowed funds.
You Extend Your Home Payoff Horizon
It could seem like paying off your home is so far off, what’s another $50,000 or $100,000?
But cash-out borrowing puts you back in two ways:
You add a substantial amount to your loan balance
You reset the mortgage clock at 30 years
In 10 years, paying off your home could be a real possibility, but only if you’re careful about how you’re pulling money out.
Many More Reasons
There could be some situations where it makes sense to pull home equity out to invest in markets. But for the vast majority of homeowners, it’s probably too risky.
Bottom line: The lender has recourse to seize the house for non-payment. No one has the right to take your house for having a smaller stock or crypto portfolio.
