Chances are you’ve built up a lot of equity in your home over the past few years, thanks to rising home values and the fact that you’ve been paying down your mortgage balance. You can tap into this equity in the form of a cash-out mortgage refinance. The cash you take out at closing can be used for virtually anything you want – even investing in the stock market.
The appeal is clear: The basket of stocks that make up the S&P 500 rose nearly 27 percent in 2021 (the average return on that index has been about 10 percent a year over long periods), while mortgage rates averaged 3.28 percent in Bankrate’s latest survey. The idea is that savvy homeowners can tap their home equity and reap investment gains that outpace their mortgage interest — and therefore grow wealthier over time.
But this may not be the best use of your cash-out equity. Making Wall Street investments can be risky, and it can take a while to recoup the costs involved with refinancing. Weigh the advantages and disadvantages carefully and determine if this tactic is right for you and your needs.
Are you allowed to use a cash-out refinance to invest in stocks?
The good news is that you can use the cash you take out at closing during a refi for just about anything you want, from funding a home improvement project or paying down outstanding high-interest debt to covering the cost of a wedding or college tuition.
“You are allowed to use your cash-out refinance money for whatever you like. Typically, people will use the cash for home repairs and improvements, but you don’t have to,” says Nate Tsang, founder and CEO of WallStreetZen. “Just because the money is coming from your home’s value doesn’t mean it needs to stay there.”
There are also no restrictions on doing a cash-out mortgage refinance, if you’ve built up significant equity in your home, and then turn around and invest those funds in the stock market, according to Daniel Milan, managing partner at Cornerstone Financial Services in Southfield, Michigan.
“You merely complete a cash-out refinance with the lender of your choosing and then, after receiving the cash, you can transfer it to a brokerage account and invest accordingly as you so desire,” Milan says.
The pros of this strategy
As with any financial endeavor, there are pluses and minuses to ponder. Consider the possible benefits carefully.
“First, the advantages of funding stock market investing via a cash-out refinance are multiple. You’ll likely lock-in the funding at a lower rate of interest, since interest rates on secured mortgage loans are relatively lower than for any unsecured loan,” says Lyle Solomon, a financial expert and principal attorney with Oak View Law Group in Rocklin, California. “Also, the money you get from a cash-out refi is not taxable, since it’s not considered as income.”
Additionally, with a cash-out refi, you can get access to your money within weeks and then begin turning that into long-term profit through investing, if your returns are favorable.
“And the returns you’ll see can be greater than the value you’d gain from your home’s appreciation if you had not pursued a cash-out refinance,” Tsang adds.
The cons of this strategy
The biggest downside to using liquid funds from a cash-out mortgage refinance to invest in the stock market is that the stocks, funds or other investment vehicles you choose can decrease in value.
“There is no guarantee of getting a positive return when you invest in the stock market. You can lose money and you’ll still have to repay the mortgage loan, too,” cautions Solomon.
Also, closing costs can average 2 percent to 5 percent of your amount borrowed, which can add up to thousands. This can be the equivalent of paying a 2 percent to 5 percent load on a mutual fund, which would be unacceptable to many investors today.
In addition, completing a refinance can take up to two months.
“While devoting this time, the stock market may take a downward turn and not look as attractive anymore,” Solomon says.
What’s more, you’ll increase your risk of foreclosure when taking out more debt on your home.
“This debt has to be paid off with your existing cash flow, and if that cash flow goes away – say by losing your job – you stand a greater chance of losing your property,” says R.J. Weiss, a Geneva, Illinois-based certified financial planner and founder of the personal-finance site The Ways to Wealth. “Combine this scenario with a market decline and you could end up losing your home and seeing your portfolio drop by 30 percent or more.”
As if those weren’t enough good reasons to avoid this strategy, consider that stocks are currently at record high valuations.
“If you were to invest your entire cash-out refinance proceeds in the stock market, there is a high likelihood that you could see a major decline in your investment if and when there is a market correction,” Weiss says.
Nick Bormann, an investment advisor representative and managing member at Bormann Wealth Management seconds those sentiments.
“For this strategy to work, your return from the stock market would have to be higher than the additional interest you will pay as a result of pulling out your home equity and possibly extending your mortgage, plus the closing costs involved,” says Bormann.
Are you a good candidate for using a cash-out refi to invest in stocks?
Solomon says you should fit several criteria to be a worthy candidate for investing in the stock market, including:
- Your debt-to-income ratio should be below 40 percent.
- Your credit score should be 700 or higher to get a lower interest rate.
- After cashing out, your home should retain at least 20 percent equity.
- You earn well, have a reasonable budget, and save a decent amount every month.
- You have the risk tolerance to handle the ups and downs of the stock market.
- You are seeking a long-term investment.
- You are saving appropriately for retirement.
“Additionally, you must be able to afford the potential increase in your monthly mortgage payments,” adds Milan. “Those who cannot should probably not pursue a cash-out refinance to invest in stocks.”
Instead of putting your home at risk in the event you default on your loan, a better option might be to make stock market investments using your savings.
“By doing so, you won’t put a burden on your household budget to repay the mortgage loan, and you will lower your stress level,” says Solomon.
An alternative approach is to pursue a cash-out refi but use the cash at closing to pay off high-interest debt.
“Then, using the excess cash flow gained from the lower interest rates, maximize your tax-advantaged investment accounts while dollar-cost averaging into the market,” Weiss says.
Or, consider refinancing at a lower rate but without cashing out any equity.
“Then, invest the monthly difference between your old payment and new payment into an investment account,” Milan says.
Regardless of how you plan to pay for stock market investments, aim first to save for retirement, and always make sure you have an emergency fund set aside, Solomon advises.
What to consider before using your cash-out refinance to invest in stocks
If you are determined to put your money into the stock market, it’s essential to choose wise investments based on several criteria, including your age, projected retirement date, risk tolerance and other factors.
“While investing in stocks, mutual funds, or any other chosen investments, make sure you build a sound investment portfolio,” says Solomon, who suggests working with a skilled investment advisor. “I recommend selecting low as well as high-risk investments. By doing so, you can get high returns and reduce the risk of losing your entire invested amount.”