Using a HELOC to Invest in Stocks: Savvy or Foolish?

There are no lending rules against using a HELOC to invest in stocks.

But this strategy is generally too risky for the average homeowner.

It could work out well for above-average investors, or just lucky ones. Others will lose capital yet still have to pay interest on the borrowed money.

Anyone considering this strategy should first examine the worst-case scenario. If they could recover from it, they might consider using a HELOC to invest in stocks.

See if a HELOC is right for you.

Start With the Worst-Case Scenario

It’s hard to imagine everything going wrong when everything seems to be going right.

A bi-weekly paycheck, outsized market returns, and rising home equity are all working for you. The lack of a serious economic downturn for 16 years (COVID was just a blip for markets) can make it seem like things will always be this good.

So you take a $100,000 HELOC to invest. The market tanks 30%, leaving you with $70,000 in holdings. You lose your job, making the $700-per-month HELOC payment hard to cover.

To make matters worse, your home value drops. You can’t sell or refinance because you owe more than the house is worth.

You lose the home to foreclosure, putting a black mark on your credit for seven years. You are financially wiped out.

While this is a dire outcome, it’s entirely possible. Those who are considering investing using HELOC funds should be in a financial and emotional position to weather the worst-case scenario by having:

• A large emergency fund

• The ability to sell the home or refinance assuming a 20% drop in home values plus the extra 10% it will cost to sell

• Secure employment

• The mental stamina to take a huge loss

For most people, the stress of using borrowed funds to invest isn’t worth it.

Massive Returns Needed to Turn a Profit

The only reason to endure the stress and risk is for sizeable returns.

But that may not be possible in today’s environment.

HELOC rates are based on the prime rate. Prime rate, which historically normal, is high compared to the last 16 years. As of this writing, it is 8.5%, up from just 3.25% in March 2020.

So a HELOC at “prime plus one” was 4.25% in 2020 but 9.5% today.

There are few investments where you can safely make a 9.5% annual return. And that’s just to break even.

If you want to make money, your return would have to be about 13% to 15% annually or higher to turn a meaningful profit.

The HELOC-for-investment strategy works best when interest rates are low and the stock market is doing well.

While many stocks in the tech and AI space are turning massive gains at the moment, these sorts of trends can reverse with no notice. Using borrowed funds in trendy sectors could turn out badly.

The good news is the Federal Reserve could start cutting its federal fund rate, bringing HELOC rates down. A large cut could make the strategy more feasible, but still incredibly difficult.

Giving Yourself the Best Chance to Win

If you are still considering this strategy, here are some tips to give you the best chance of success.

Make a plan: Create a document detailing your investment strategy: what you’ll invest in at what price, your acceptable loss threshold, and your exit strategy. How and when will you pay off the HELOC?

Avoid closing costs: Many HELOC lenders won’t charge any closing costs. Shop around if your lender quotes high upfront fees.

Shop for rates: HELOCs are based on the prime rate. Shop for a HELOC at or below prime. A $100,000 HELOC is $125 per month cheaper at “prime minus one-half” compared to “prime plus one.”

Check today's HELOC rates.

Read the fine print: Many HELOC lenders charge an early closure fee, an annual fee, and other expenses that will eat into your profits.

Get advice: It could be worth hiring a financial advisor to avoid common mistakes.

Talk to a CPA: HELOCs and investments can put your tax situation in a blender. Unforeseen taxes may eat into profits. Talk to a tax professional before starting.

Alternatives to Using a HELOC to Invest

If you decide tapping into home equity is too risky, you still have options to increase investment holdings.

Budget: Put 5-10% of your income into investments each month. This will give you outsized returns without risking your home or paying extra interest.

Dollar-cost average: Put money in the market at regular intervals is safer than placing a huge sum in the market at once. Dollar-cost averaging minimizes over-investing at the wrong time.

Maximize your employee-sponsored 401k: Many employers match your 401k contributions up to 4-5% or more. And a 401k allows you to invest pre-tax. Maximize these advantages before considering exotic investing ideas.

Invest existing low-interest savings: You might have a 6-month emergency fund or low-interest checking and savings accounts. Invest these funds in a high-yield savings account or a conservative mutual fund or ETF.

Investing HELOC Funds: Move Slowly

Don’t get too eager to pull money out of your home to invest. Give yourself a few weeks to think about the decision, talk to experts, and consider alternatives.

Only after careful consideration should someone tap home equity for investments.

Speak to a licensed home loan professional here.

This article does not constitute investment advice. Speak with a licensed professional before investing or filing taxes.