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Why Using Home Equity to Invest in the Stock Market is a Bad Idea

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Not that I needed one but an email newsletter that I received from attorney Dale Ledbetter recently served as an excellent reminder what a poor idea using home equity to invest in stocks really is.  From his email:

Strong stock market encourages the resurrection of a bad practice – borrowing money against the value of your home to play the market. The horror story set out below is likely to be repeated if these practices continue.

A married couple, both of whom were in their late 80s, was persuaded by their bank to take out 100% value equity line of credit against their home. They were then persuaded to turn these “borrowed assets” over to the bank’s securities subsidiary where they were told the return would easily exceed the cost of the credit line. 

The broker then advised the couple to put 95% of the total proceeds into a single stock. The securities account tanked, resulting in an almost 100% loss. In the meantime, the house dropped in value by $100,000, resulting in a foreclosure proceeding. The bank then refused to permit a $150,000 short sale to bona fide buyers. 

The husband died. The wife, who now lives in a constant care facility, is entering bankruptcy to force the bank to take the house. 

Of course, the bank and their securities subsidiary blame it all on the elderly couple who they described as “sophisticated investors.” Both husband and wife had been schoolteachers and had no training or experience in the securities industry or in investment strategies. The fact that both were in their late 80s and suffering from diminished capacity, was not enough to deter the aggressive sales tactics of their “trusted advisors.” 

Aside from what would seem to be blatant investment fraud on the part of the bank and their advisory unit, this piece reiterates why using your home equity to invest in the stock market is such a bad idea.  Here are a few specific reasons that I discourage this practice.

Did you really forget the 2008 housing market crash this soon? 

For those with short memories an overinflated housing market crashed and triggered a meltdown in the economy and drastically reduced the value of many homes.  We are still recovering from this and although home values have improved in many parts of the country we learned that home prices will not always go up and that real estate is not the safe store of value we were led to believe.

To put this another way let’s say you tap your home equity to invest in the stock market.  What if the value of your home decreases 10 percent, 20 percent or more?  Now you have to pay back that home equity loan on a house that isn’t worth nearly as much as when you took out the loan.  You could find yourself underwater on your home or worse in foreclosure.  You could also find that your plans to fund a comfortable retirement or your children’s college education are out the window.

What if your investments tank?

Much like these poor folks in Mr. Ledbetter’s example above, not all investments are a sure thing.  What happens if you borrow against your home equity to invest in the stock market and things don’t work out?  If the specific investments you or someone else chose drop in value you are now stuck with investments worth less than your original investment and you will be stuck paying off the loan which is still based upon the amount borrowed.

Even if you went with a few index funds and the stock market drops you will find yourself in the same boat.  Again this is a great strategy to ruin your otherwise well-planned financial future.

Who exactly is suggesting this idea? 

Like the poor folks in Mr. Ledbetter’s example take a look at anyone suggesting this idea to you with a very jaundiced eye.  What is in it for them?  Are you the only one with any real skin in the game?

In the example above the bank won at last twice.  They got the interest on the loan and their brokerage unit made money via fees and perhaps other sources on the investment side.  They had no skin in the game and will likely come out whole even after the foreclosure.  

The Bottom Line

Generally, in my opinion, anyone who would suggest this idea to an investor is motivated by greed and does not have the best interests of their clients at heart.  Using your home’s equity to invest in the stock market is just not a sound idea.

There might be instances where tapping home equity to invest can be a good idea, but these are very limited and should only be undertaken by truly sophisticated investors who fully understand the risks involved.

Please feel free to contact me with your questions. 

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Comments

  1. H. justice says:

    The article about the elderly couple being conned into borrowing agsinst their house to invest in a single stock is probably the most important article you have ever written, especially if it keeps others from doing something similar. I’m a pretty good investor who has never used borrowed money including margin to invest and my returns are greater than the market. I do not believe in getting greedy and trying to juice returns with borrowed money.

    • Roger Wohlner says:

      Thanks for your comment. The part about the couple is a quote from the attorney I referenced and when I received that via email I really wanted to share with my readers. As you say I hope that it prevents others from being victimized. The last sentence in your comment is very powerful and well-said, kudos on your success as an investor and your approach.

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