Here's an enticing strategy: Borrow money at today's low interest rates, then invest it at a higher return, pocketing the difference. Sound like a no-sweat road to riches?
Here’s an enticing strategy: Borrow money at today’s low interest rates, then invest it at a higher return, pocketing the difference.
Sound like a no-sweat road to riches? Sure. And growing numbers of Americans are being seduced by this siren song of easy money, borrowing against their homes to buy stocks, apparently oblivious to the steep risks.
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So alarming is the trend that the National Association of Securities Dealers (NASD) has warned its members they can run afoul of brokerage-industry regulations by urging the strategy on small investors.
The maneuver involves taking cash, or “equity,” out of a home by refinancing with a new mortgage larger than the amount owed on the old one, or by taking a home-equity loan, using the property as collateral.
Equity is the difference between a home’s value and the debt remaining on the mortgage, essentially the profit you could make if you sold the property.
The borrowed cash is used to buy stocks or other investments, in hopes the investment return will be greater than the interest rate on the loan.
The danger is the investment may lose money. Worst of all, homeowners burdened with additional debt can fall behind on payments and lose their homes.
The NASD warning said homeowners appear even more likely to use home equity to pay for stock purchases today than they were during the stock bubble of the late ’90s.
Citing a Federal Reserve study, the NASD said that in the bear market of 2001 and the first half of 2002 — the most recent period examined — 11 percent of cash homeowners got through refinancing was used to buy securities. That compares with 2 percent in 1998 and the first half of 1999, when stocks boomed.
The NASD thinks the practice has grown since the study. And the amount of borrowed home-equity money used for investments, an average $24,000, was more than for most other uses.
The NASD is concerned some stockbrokers are part of the problem, urging investors to tap home equity to execute trades that generate commissions.
Low interest rates and rising home prices are also factors, making it easy for homeowners to pull cash out of properties.
But rates on equity lines of credit move up or down as prevailing rates change. The 4 percent rate that looks good today could rise, turning any potential profit from stocks into a loss.
The worst case would be if your home price falls. You could end up owing more than your home is worth.