In the wake of my back and forth with Linda Stern, I took the advice of commenter Kid Dynamite and moved the discussion to email. Here’s how it went:
Felix: Why do you think it makes sense to borrow against your house to invest in the stock market? And if it makes sense for people buying houses, why doesn’t it make sense for people owning houses? If I own my home outright, should I take out a mortgage and invest the proceeds in a mutual fund? If not, why not?
Linda: My advice, intended for first time homebuyers who are trying to save up for a down payment, was based on the belief that both mortgage interest rates and home prices will rise faster than they can accumulate big down payments. Using leverage like this allows them to lock in a historically low mortgage rate and a home price, and start building equity in a home. If you already own a home, you wouldn’t need to lock in the home, so, no, I don’t think it’s necessarily wise to remortgage it for investment cash. That being said, if you have an outstanding mortgage with a fixed interest rate of 4.8 percent or less, I think it would probably be the better bet to take any extra money you have and invest it in a diversified fund instead of using it to pay off your mortgage early. If you could do that through a tax-advantaged retirement vehicle, that would be even better.
Felix: OK, let me try again. It seems to me, just like it seems to my commenter Kid Dynamite, that you’re making two different claims in your posts. The first is that first-time homebuyers without much of a downpayment should buy now anyway. The second is that even if you do have a large downpayment, you shouldn’t put it all into your house, and instead you should invest that money in a diversified mutual fund. I’m trying to concentrate on the second claim here. So, let’s build four different scenarios here; let’s assume they’re all at an interest rate of 4.8%, and that in every case the homeowner can comfortably make her mortgage payments.
- Alison is buying a house for $250,000. She has $50,000 — 20% of the price — in savings which she can use as a downpayment. You suggest that she should not put all that money down, and instead should invest some of it in the stock market. “The less you put down,” you write, “the better off you are”. So if Alison can buy the house with just 3.5% down, or $8,750, should she be investing roughly $40,000 of her savings in the market rather than using that money as a downpayment?
- Brenda already owns her house, which is worth $250,000, and it carries a $200,000 mortgage which she wants to refinance. If the lender is willing to refinance for more than $200,000, should she accept the offer of a cash-out refinance and invest that new cash in the market?
- Christie is in the same boat as Brenda, except that her outstanding mortgage, which she wants to refinance, is much smaller — just $50,000. How much should she refinance for, in the knowledge that she will take any extra cash and invest it in a mutual fund?
- Debbie owns her house, worth $250,000, outright. Should she take out a mortgage of any size at all, and invest the proceeds in the market?
In each case, homeownership is a given: Alison, Brenda, Christie and Debbie are all going to own that house either way. I’m just trying to zero in here on the idea that you should borrow against your house and invest the proceeds in stocks. When is that a good idea, and when is that not a good idea? And if it’s a good idea for Alison to have less than $10,000 of equity in her home, why is that not also a good idea for Brenda, Christie, and Debbie?
Linda: Sorry, Felix, you’re not going to get me to give individual advice about who should and who shouldn’t use home equity to invest in the stock market. That depends on many variables that you don’t go into here: How much do you already have saved for retirement or invested elsewhere? How intelligently do you invest? What’s your ability to withstand risk? When will you need the money? How comfortable is your income stream? Etc. etc. etc. My main point is that a homeowner who can comfortable make their mortgage payments on a fixed 4.8 percent home loan could probably find better places to put extra cash, rather than buying down the loan. For someone, that might be an emergency fund. For someone else, that could be a Roth IRA invested in a balanced mutual fund. I’m not going to tell any of your readers or mine to remortgage their paid-off homes and put all the cash in stocks. But I’m sure there are some folks out there — well-heeled and well-capitalized folks — who would do that, and would end up happy for it.
Now let me answer your question another way: I, personally, have taken cash out of my paid-off home to pay for home repairs while at the same time contributed money to my IRA. Isn’t that the same thing?
Felix: Linda, of course I wasn’t asking for individual advice any more than you were giving individual advice when you wrote your initial posts. But back then you seemed quite happy to generalize and say that the less you put down, the better off you are.
My point is that your advice seems to be, shall we say, path-dependent. If you start off with no house, then you’re advising putting as little money down as possible. If you start off with lots of house, on the other hand, you’re shying away from making the same advice to lever up, even if it brings the homeowner to the exact same place.
Economics is full of cases where people will make different choices depending on how the choices are presented. Here’s a good example. But as personal-finance columnists, it’s incumbent upon us to point out those areas of irrationality and to to say that if you have the choice between A and B, then you should plump for the outcome which makes the most sense, regardless of how you get there. The choice facing Alison is the same as the choice facing Brenda. Your original column was quite clear about what Alison should do, but now you’re backtracking on what Brenda should do. And that’s why it seems to me that what you’re advising is irrational.
For me, the choice in all cases is clear: it’s pretty much always a bad idea to borrow money and invest it in the stock market — and it’s an even worse idea to borrow money against your house and invest it in the stock market. Because that way you not only risk losing money in the market, you also risk losing your house. I’m sure you can come up with an extreme example of “well-heeled and well-capitalized folks” for whom your idea might make sense, but even there I’m having difficulty working out why people who are so well-heeled (and who therefore have diminishing marginal utility of future returns) would feel the need to leverage their investments in such a manner.
I’m quite happy saying that my advice applies to at least 95% of the homeowners in the country. Yes, individual risk appetites vary, as do total savings and the like. Individuals are unique. But this is one area I feel very comfortable generalizing. Leveraging your stock-market investments with unsecured debt is dangerous; leveraging stock-market investments with secured debt is downright foolish.
Does that mean you’re foolish to borrow money against your home while still contributing to your 401(k)? Maybe not — 401(k)s are special, in terms of tax treatment, and if your employer is matching your 401(k) contributions then of course it makes sense to maximize them first. On the other hand, I do find it revealing that you borrowed specifically “for home repairs”, which are a very prudent expense, rather than for stock-market speculation.
Let’s say that you, Linda, didn’t have any home repairs this year, and that you had maxed out your 401(k). In that case, would you still have borrowed against your house, and put the proceeds in the market? I suspect not. On the other hand, let’s say you were buying your house. In that case, would you follow your own advice and put as little money down as possible, leaving the rest for investment in the market? If so, then I’m detecting an irrational inconsistency here. No?
Linda: As I’ve already said, I think the two examples — (1) someone buying a house for the first time and (2) someone refinancing a home to take money out isn’t the same thing. Alison and Brenda are two very different people! I think the person buying a home is using the leverage afforded by the low down payment to get the house in the first place. (Locking in loan, home price, beginning to build equity, saying goodbye to rent.) The person refinancing a home they already own is putting more at risk — the home — and spending money on closing costs etc. to get that investment money.
Now let me ask you a question. What about Alison, the homebuyer who has that $50,000? She could put it all down on the house, building 20 percent of equity immediately. Or she could put $8750 down, and have $41,250 left. Wouldn’t that money, invested cautiously or saved in a liquid account, better protect her from bad financial times (job loss, housing price decline, etc. etc.), than having it all tied up in the house? Again: from the homeowner’s point of view and not the bank’s.
I do think there is value, and not irrationality, in making “path-dependent” decisions, and in gradations of behavior. Taking some affordable amount of money out of home equity and investing it might make sense in some situations — such as putting it in that retirement account and that balanced mutual fund, even in the absence of home repairs. Cashing in the place where your kids sleep at night to make a big bet on Apple doubling one more time? Not so much. I didn’t recommend that kind of speculation in either of my posts.
Felix: OK, thanks Linda, I think we’ve probably wrung this one dry — although I’d point out that $41,250, if “saved in a liquid account,” is very unlikely to yield more than 4.8%.
I did promise you the last word — so, anything else you want to add before I publish this?
Linda: This has been fun and I look forward to doing it some day with wine. I think I’m done.