If you are offered a refi cash-out of less than 2%, should you invest the money?
With mortgage rates still close to their all-time low (some 15 year rates are close to 2% and 30 year rates less than 3% as you can see here) and performing stocks, this question from a MarketWatch Picks reader intrigued us:
âI’m 60, retired and debt free, including my South Florida condo. I received an offer for a 15 year mortgage at 1.75%. I earn a lot more than that in my investment account. I am considering refinancing, withdrawing money and investing that money. My investment advisor is strongly against the idea. He doesn’t want me to go into debt and thinks I should preserve my equity in case I need it later in retirement. Who is right ? ”
We asked financial planners what they think of this issue and if other people with home equity might consider a similar move. Here is the verdict. Yes, it is true that mortgage refinancing rates are close to their historic lows, and those with excellent credit scores can find refi rates of around 2% right now. And your investments could easily return more than 2%: at the end of October, the Standard & Poor’s 500 index is up more than 21% for the year.
But while the return on a low-cost ETF can easily exceed 2%, it’s not just the interest rate at stake here. This is because you would also be paying off the loan principal as well as the low rate interest.
Example: You get $ 50,000 from a cash refinance and invest it in an ETF that tracks the Standard & Poor’s 500 Index, producing a 20% gain for the year. (Note that the average return since the mid-1950s has been between 7% and 8%.) That’s a good gross return of $ 10,000. However:
The payment on the new mortgage of $ 50,000 at 1.75% is $ 316.03 per month, for a total of $ 3,792 for one year;
You will have one-time closing costs on your refi or home equity loan. Typically, this is 3% of the loan balance, or $ 1,500 in your case;
Now your net profit is reduced to around 9%, and that does not include trading fees and taxes on your investments.
Still, you made $ 4,708 in the first year, which is a fair bit of change.
It won’t happen every year, warns Greg McBride, chief financial analyst for Bankrate.com. If the $ 50,000 you invest pays 7% for a year, you will earn $ 3,500. This means that your investment produces $ 300 less than what you will pay on the new mortgage in a year. But, thanks to the magic of composing, you will still earn money over time. This is because $ 50,000 invested at an annual return of 7% will generate almost $ 88,000 of return over 15 years. Even if you took the money out for the mortgage payment at the start of each month, you would still come out after 15 years with a profit of over $ 39,000.
âFor the savvy investor who thinks long term, the rate of return opportunities can be very profitable with such a low cost of borrowing,â said McBride. âBut we’re talking about buying an S&P 500 or a total market index that can last for decades. It is not a strategy for day trading or even investing in stocks.
Another consideration is your ability to stay up to date on your new mortgage without touching the money you invest. You also need to think about how investing in home equity fits into your overall financial plans, said Scott Smith, certified financial planner and senior advisor at Lifecycle Financial Planners in Bloomfield Hills, Michigan.
“I don’t recommend taking all of the 80% of the equity that can be borrowed, but if it was 40% to 50% of the equity – especially since it can repay the loan s’ it needs it – I would probably recommend it. Smith said. âWe frequently recommend it to customers. “
Typically, financial planners advise using home equity loans to finance home renovations or to pay off credit card balances or other high rate debt, but you don’t have these issues. Ultimately, your own planner will be in the best position to know your finances, and possibly the best.