Does it make sense to use a home equity loan or HELOC to invest in stocks?
Wondering if you should take a plunge into the stock market using HELOC funds? The answer is: maybe. You definitely can use your equity to finance investments, including stocks, bonds, or mutual funds. The answer to whether you should use a HELOC to fund investments such as stocks is more complicated and depends on the overall picture of your assets, your HELOC interest rate, and your expected returns rate on investments.
Key Overview:
A home equity line of credit, or HELOC, can be used for any purpose, including investing in stocks, bonds, mutual funds, or real estate
Using a HELOC to invest in stocks can be risky due to market volatility and unpredictability
Having a plan for repaying the HELOC rapidly will help you gain the most from your investment
In order for using HELOC funds for investment to make sense, you need to have a higher rate of return than the interest you are paying on the loan
Keep in mind that a HELOC is secured by your home, so if you default on the credit line you risk losing your home to foreclosure
How a HELOC works
If you need funds for investment and own a home, you might consider a home equity line of credit, or HELOC. This type of credit is revolving, meaning you have a borrowing limit rather than a lump sum payment. You can withdraw money from the credit line as needed, similar to using a credit card. The interest you pay is only on the amount you withdraw, not the full limit amount.
Your credit limit is determined by your home's value, allowing you to borrow a percentage of what you own (usually 80-90%). HELOCs are typically split into two periods: The draw period (around 10 years) and the repayment period (around 20 years). During the draw period, you can withdraw funds and only pay interest on the balance (not the principal). After this period, you cannot continue to withdraw funds and must repay both principal and interest.
When does using a HELOC for investment purposes make sense?
Using a HELOC to finance investments can be a smart move, but it is important to consider the potential risks. Before committing to a HELOC for investing in stocks, bonds, or mutual funds, evaluate your current financial situation and understand the associated costs and risks.
Your expected return rate on investments should be higher than the interest rate charged on your HELOC. Interest rates on HELOCs are tied to the prime rate and can be variable or fixed. Normally HELOC rates range from 6-10%, depending on market conditions, your credit score, and your debt-to-income ratio.
If you believe you can make more money by investing than by paying off your loan with regular payments, then using your equity via a HELOC could be worthwhile. Many investors prefer to use their available cash rather than taking out additional loans to invest, as this reduces risk of over-investing.
Tips for success
Have a plan for repayment
Using a HELOC to fund a stock market investment makes the most sense when you have a plan for repaying the HELOC quickly. One way to ensure that a HELOC investment strategy works out in your favor is to create a repayment plan. Developing a plan for how and when you will pay off the loan can help make sure you don’t get stuck with high interest payments down the line.
One option is to use the money earned from investment gains to repay your HELOC as quickly as possible. This approach minimizes interest payments and helps preserve your capital. As with any debt, it’s important to make regular payments on time so as not to incur additional fees or damage your credit score.
Another strategy is to set up automatic monthly payments directly from your bank account to ensure your debt is paid on time. Many lenders also offer flexible repayment options, such as bi-weekly payments or accelerated paydown plans. If you do choose to use a HELOC for investing in the stock market, it’s important to understand the risks and have a plan for repayment.
Don't withdraw more than you need
One of the benefits of a HELOC over other forms of home equity-based borrowing (such as home equity loans and cash-out refinance mortgages) is that you can choose how much to withdraw from your credit line instead of receiving a lump-sum payment at the start of the loan. Make sure to only withdraw the funds you need so you aren't stuck paying interest on a greater amount than what you are generating returns from.
Think about the return on investment
It's important to take into account your interest rate and borrowing costs when deciding if using a HELOC to fund a stock market investment makes sense. Borrowing costs include closing costs and other fees, such as usage fees, annual fees, repayment fees, and appraisal fees. In addition, the bank will add a 1-2 percentage points margin in order to make money off of your loan.
The return on investment for your stock should be considerable - at least 10% - in order to make sense. This should cover the interest on the HELOC while you work to pay down the principal balance.
Have good credit and a reliable source of income
Having a good credit score, repayment history, and income will help you get the best interest rate possible on your HELOC. Your debt-to-income ratio should be no higher than 50%, and your income should be able to cover the monthly payments.
Pros of using a HELOC for investing in the stock market
Competitive financing:
HELOCs are generally more affordable than other forms of financing, such as personal loans. This can be beneficial if you need to borrow money for a short period of time. When using a HELOC to fund stock investments, it's important to have a plan for repayment as quickly as possible. It's also wise to only draw the amount you need to invest and not above that amount in order to reduce your risk of defaulting on the loan.
Convenient access:
Accessing funds is easy and quick with a HELOC since it is tied to your home equity. A HELOC from Figure can be approved and funded in as little as a week, wasting no time to get your hands on the stocks you are eyeing. You can draw the money you need to invest with the ability to redraw, instead of receiving a one-time payment as you would with a home equity loan.
Cons of using a HELOC for investing in the stock market
Unpredictable markets:
The stock market can be unpredictable and volatile, meaning that your investment could go up or down in value quickly. This means that if you are using a HELOC to invest in the stock market, you are taking on an additional risk due to the potential of having to pay back a higher amount than when you took out the loan.
Risk of defaulting:
If your investments don’t work out as planned and the stock market takes a downturn, you may not be able to repay your HELOC in time. If this happens, it could lead to foreclosure on your home or other financial difficulties. Additionally, if you miss payments on a HELOC it could damage your credit score.
Loss of equity:
If the value of your investments decreases, you may need to sell some stocks or other assets in order to pay off your HELOC. This could result in a loss of equity and potentially put your home at risk if the sale doesn't raise enough money to cover the loan amount. It’s important to make sure that your investment strategy is sound and that you have a plan for repayment before taking out a HELOC.
Final Thoughts
Using a HELOC to finance investments such as stocks, bonds, and mutual funds can be a smart move - but it is important to understand the associated risks and costs. Be sure to evaluate your current financial situation in order to make an informed decision about whether or not this strategy makes sense for your unique situation. Additionally, consider that your expected return rate on investments should be higher than the interest rate charged on your HELOC in order for this strategy to be worth considering.
This article is published for informational purposes only and is not intended to provide, and should not be relied upon for financial or investment advice.
