Considering borrowing against your home to invest? Better think again
By Michael D. Larson • Bankrate.com

George McReynolds knows what borrowing against home equity in order to invest can do.

As the Feasterville, Pa., mortgage lender recalls, one of his acquaintances owned his home free and clear in the 1980s. Then an investment representative talked him into taking out an equity loan for 90 percent of the value of that property so he could plow the money into limited partnerships. Ten years later, those partnerships are worthless. But guess what? He's still making payments on that mortgage.

"The hottest investment of the '80s was limited partnerships, cable TV and real estate partnerships. In the '90s, the hot investment is tech stocks and IPOs. In the early '70s, it was the Nifty Fifties. Each decade has had its great, hot, go-to-the-moon investment," says McReynolds, a vice president of lending at Warrington Mortgage Corp. who's also a licensed stockbroker. "If you have a winning investment, leverage works.

"But leverage cuts both ways," he adds, especially when you borrow against a home. "If an investment goes down, you still owe."

Hard to tell how many investing
It's difficult to pinpoint how many homeowners are tapping their equity to invest today. Lenders say most home equity loan and line-of-credit customers don't give it as their reason for borrowing, and industry surveys show that refinancing debt is the top use for both products. One 1999 study by the Consumer Bankers Association found investing was cited in less than 3 percent of cases.

But experts point out that customers have no obligation to say if they're borrowing to invest. Lenders seem neither interested in following up on where their money goes nor worried if it finds its way to the stock market. Indeed, banks as diverse as tiny Horizon Financial Corp. of Bellingham, Wash., and giant Wells Fargo & Co. of San Francisco helpfully suggest that home equity loans be used for investing right on their Web sites.

Anecdotal evidence suggests that borrowers have taken the bait, and some experts say they're aren't surprised. After all, the gains turned in by initial public offerings, consumer- and business-oriented Internet stocks and biotechnology shares at various times during the past few years tend to embolden people to go after the big score via leverage.

The appeal is simple: Like traditional margin loans, home equity loans can help investors boost their buying power. In both situations, borrowers use assets as collateral for the loan. With margin loans, those assets are stocks, bonds or other financial instruments. With equity loans, they're houses, condominiums and other tangible properties.

There are no restrictions
But while margin investors face government and lender restrictions on how much they can borrow and how much of their portfolios' value can be made up of borrowed money, equity customers face no such limits. Margin investors can purchase, at most, $10,000 worth of stock with $5,000 in cash, for example, while equity investors can spend their entire loans on whatever they want. That means someone with decent credit and stable employment who owns a $150,000 home without any mortgage debt can potentially buy $150,000 worth of stock or more, considering many lenders today couldn't care less whether a homeowner has equity.

"We offer products from 80 percent LTV up to 125 percent on some term loans," says Tim Tierney, vice president in charge of direct lending, sales and training for Old Kent Financial Corp. in Grand Rapids, Mich. "People can come in and get a home equity loan to satisfy whatever legal purpose they want."

But should they? One Midwest investor says yes. By getting a line of credit, tapping it occasionally to buy low-risk stocks and using some of the profits to reduce the principal balance instead of just paying interest, consumers can boost their returns without assuming too much risk.

"It does work if you watch what you're doing," says Larry Christensen, 49, a truck parts salesman who lives in Addison, Ill. "I've done it myself but kept it sort of low-key and kept it as risk-free as possible. It's worked for me."

One man's story
Since the late 1980s, Christensen says he has used two separate lines of credit to boost his investment performance. He currently has about three years left on a 10-year, $50,000 line of credit and has been able to pay off the portion of it used for playing the market, thanks to rising share prices. Real estate values in the Chicagoland area have gone along for the ride, so Christensen hasn't faced much equity risk either. The house he bought for $55,000 24 years ago is paid off except for the $16,000 or so left on his credit line from miscellaneous charges and he plans to sell it for about $160,000 this summer.

"You sit down and even if you have to talk with your broker, tell your broker what you want to do. Tell your man, 'I want to make some investments, good, solid, core companies and the most I'm going to go with is a moderate risk,' " he says. "They'll find them for you and go from there."

"It's nothing that's too sophisticated. It's just very, very disciplined."

Lucky timing, say experts
But experts counter that lucky timing has as much to do with the success of investors such as Christensen as smart planning. Homes appreciated at a low- to mid-single digit rate almost every year during the past decade and stock indexes turned in several years of gains exceeding 20 percent. Meanwhile, the economy hasn't seen a recession since the last time a member of the Bush family was in the presidential spotlight. That gave borrowers the right combination of economic factors necessary for the strategy to work.

How so? Stable employment provided homeowners with cash they could use for principal and interest payments on their loans. That prevented them from having to sell the stocks they bought to raise cash, allowing those stocks to increase further and faster in value. The fact those stocks rose so quickly meant the dollar appreciation of their investments exceeded the cumulative interest they had to pay out. Anyone who got in trouble with their investments had a safety valve, too. Rising property values allowed them to pay off their loans by selling the homes securing them.

"Real estate prices have somewhat moved in tandem with the stock market and it's no coincidence real estate prices in Palo Alto (Calif.) have gone through the roof as technology stocks have gone through the roof," says Ross Levin, a certified financial planner with Accredited Investors Inc. in Edina, Minn. "There's absolutely no doubt you can potentially make money if the market goes up."

When the bottom drops out ...
But that isn't always what happens -- and consumers who use home equity money are in the worst position should a real estate, stock market or economic collapse strike. While regular investors might lose money in their portfolio and margin investors may get stuck scrambling to pay off unsecured loans, homeowners can lose the roofs over their heads.

Advisers are especially concerned today because the Federal Reserve Board seems intent on slowing the economy by raising interest rates. That drives variable rates such as those charged on lines of credit higher, boosting the monthly loan payment. But it also makes mortgages more expensive and that could cause home values to stagnate. Because stocks generally don't react well to higher rates, the market could be in for even more pain than it's experienced already, too. Rising rates slow the real economy as well and that means unemployment could climb.

In other words, so much for all of those helpful variables.

"Rising interest rates would typically increase the costs of your home equity line and that's also one of the things that causes the market to implode," Levin says. "You've got borrowing costs that are increasing and secured by your most valuable resource potentially at a time when stocks aren't doing what they could do."

"I think it's a lousy idea."

With events shaping up the way they are, investors who got in while the getting was good may very well want to get out. They can do so by cashing out their investments and paying down any outstanding debt. Those who are contemplating borrowing against their equity, on the other hand, may want to consider McReynold's warning -- unless they want to be left regretting it a decade later.

"There's a saying that you should never confuse a bull market with a brain," he says. "A lot of people are looking at the fortunes that are being made investing and it looks really, really easy, but they have such limited experience."