 Cashing
out equity to invest elsewhere
|  Dear
Dr. Don,
Home equity cash out? My 45-year-old husband and
I have good salaries, a $200,000 mortgage and about $100,000 in debt
caused by a small business failure. Our home is conservatively valued
at $750,000. We have been advised to consider refinancing to pay off
the debt and to take additional cash out to invest for retirement
while interest rates are low. What is your opinion of cash out for
investment purposes? -- Lisa Loans
 Dear
Lisa,
The downside of refinancing to restructure the
$100,000 business debt is that it securitizes the debt, using the
equity in your home to back it. You haven't told me what interest
rate applies to this debt, but I'll assume that the interest expense
is tax deductible as a business expense, so you want to compare
the interest rate on this debt against the interest rate you will
pay on a mortgage refinancing. If you have no real expectation of
filing for bankruptcy at some point before this debt is paid off,
then restructuring probably makes sense.
It would also be a good idea to review your credit
reports and credit scores before you ramp up to do a cash-out refinancing
of your home. Make sure that the reports accurately reflect your
accounts and dispute any incorrect information. Most states can
now receive free credit reports once a year, but you'll have to
pay to get a credit score. The Bankrate feature, "Free
credit reports hit the South," tells you how to get your
free credit reports.
Taking equity out of your home to invest in other
assets can make financial sense. By your estimation, even after
restructuring your business debt, you have $450,000 in equity. Assuming
a maximum loan to value of 80 percent, then you have $300,000 available
to invest if you do a cash-out mortgage for $600,000.
My opinion of cash out for investment purposes is
that for most people, it's a lousy idea.
The equity is already invested -- in your home. What
you really want to know is how I feel about the idea of re-leveraging
your equity investment in the house so you can invest the money
elsewhere.
What it comes down to is your attitude toward risk.
It's easy enough to find investments that earn more on an after-tax
basis than the after-tax cost of the mortgage. Let's say, for example,
the after-tax cost of your mortgage is 4 percent. You can reasonably
expect to earn more than 4 percent on some investments on an after-tax
basis. If expectations become reality, then you're ahead of the
game by using mortgage money to invest.
Let's say you invest $300,000 in the stock market.
If the market goes down 22 percent in a year, as it did in 2002,
you would lose $66,000. You can expect the stock market to have
an average after-tax return higher than the after-tax cost of your
mortgage, but you can't count on average returns in the short run.
You want to confirm that the interest expense
on the cash-out mortgage is a deductible expense on your income
taxes. Refer to IRS Publication 936, Home
Mortgage Interest Deduction, and IRS Publication 550, Investment
Income and Expenses, or your accountant to confirm that it is
deductible.
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