Take Out a Mortgage or HELOC and Use the Cash to Buy Dividend Stocks

[BargainValueHunter]

http://www.marketwatch.com/story/can-stocks-pay-your-mortgage-2011-09-14

 

You can get a 30-year fixed-rate home loan now for 4%. That’s because the mortgage rate is priced in relation to the interest rate on 10-year government notes. And that interest rate has just collapsed.

 

The 10-year yields less than 2%, far below historic norms.

 

Mortgage interest in most cases is tax deductible at the federal (and often at the state) level. If you’re in the upper middle class you’re probably in the 25% federal tax bracket. So spending $4,000 on mortgage interest will save you $1,000 in federal taxes, and so on.

 

In other words, your 4% loan is really a 3% loan. (I’m ignoring Alternative Minimum Tax, and assuming you already itemize your deductions.)

 

Meanwhile, dividends on stocks are taxed at 15%. If a stock pays you $3.52 in dividends, you get to keep $3.

 

So if a stock yields 3.52% or better, and those dividends are either sustained or grow, it is offering you a better return than your cost of capital.

[Myth465]

I have been looking at this but I dont own a house. You can buy FTR at a 11% yield, Petrobakken at a 10% yield, Pennwest Energy at a 6.50% yield, and most international telecoms in Europe at a 10% yield. ATPG bonds are 15% YTM and I own the common. Plenty of ways to put together a portfolio yielding 7% with upside.

 

My mom is buying a house and wants to put 20%-30% down. Not much you can do to talk her out of it. I think its a good idea for those on the board, but foolish for most people. The beauty is you can lock up 20 year capital and wont have to worry about fluctuations. Swizzled talked about this being his plan in terms of investing going forward (having unlevered property going into a crisis and then taking out Home Equity loans).....

[tombgrt]

Will work fine until it doesn't and then you are f*cked.

 

Kind of what a lot of people did before the Great Depression to buy more real estate or stocks. Pure speculation and very dangerous imo, even if chances of economic disaster like in the thirties are very limited. With Greece and maybe others defaulting it isn't unlikely that dividends get cut if the economic situation should get worser. I wouldn't want to risk that, even if chances are small, unless I can hedge myself for such an event without losing to much upside.

 

Maybe you can if you have plenty of cash aside, I don't know...

 

What do others think?

 

( I am pro renting something instead of buying tho IF you have a great investing track record and are in an undervalued market with low macro threats. Also because here in Belgium for example real estate prices are getting really inflated as people believe the returns will be equally high as before. This trend looks impossible to substain imo and I believe real estate returns will diminish greatly. )

[biaggio]

like holding cash, not having to worry about paying your mortgage helps you to sleep well.

 

Taking out a mortgage with these extreme low interest rates may be good for the really smart guys here, but not for the average investor (like myself).

 

 

[CONeal]

My only thought to this idea is...

 

"Don't invest money that could leave you homeless."

 

 

People did this a few years ago and gt burned in 2008 when lenders pulled back their line of credit b/c of the housing downfall in the US.  Along with the rapid spiral in share price it just to much risk in my view.  Then again I never use leverage since its rule #1 for me.

 

[Kraven]

It's a terrible idea for all but a very few people.  You have to be disciplined and good at investing.  Borrowing against your home in order to invest and leverage yourself sounds great in theory, but if something adverse happens not only do you lose your money, you lose your home.  Has anyone ever heard Ric Edelman?  He does a weekly radio show and has written numerous personal finance books.  He is a big advocate of doing this.  It has always struck me as very bad advice for the masses.

[finetrader]

this idea is like any investment:  If stock goes up once you invest in it you will feel good about it

                                                 

this would probably work on a long term basis, but do you know many people that don't bother at all when they see an investment in the red.  In this case you could have to live many years with the idea that the equity of your house is wipeout. Not a good feeling at all.

 

 

 

[Uccmal]

Dumb, dumb & dumber....

 

Keep your home and investments separate.  Our home is in my Wife's and my name.  My margin accounts are in my name only.  I have used substantial money from my profits to pay for a complete upgrade and addition on the home and still hold outstanding LOCs from the reno.

 

These advisors seem always treat today as the status quo.  What if there is some type of liquidity crisis and your interest rates on your Heloc go to 10 percent.  At the same time all your stocks tank.  Bye bye house.  I Bought my first new car in 1990 and the interest rate was 10.9 and that was the Gmac deal.

 

Then there is the temptation to borrow on margin to juice the money from one's heloc.  As we have seen easy money can be a little addictive.

[FFHWatcher]

This strategy works amazing for the financial advisor who has a client that has $500 per month to invest.  Normally, the financial advisor would only make $25/mo (if a deferred sales charge is used) or a lot less if you do it no load for them.  BUT, if you can convince them to borrow $100k on their house, their payments are about $500/mo in interest on a HELOC.  In this scenario the advisor might get as much as $5,000 in commission and it still costs the client $500/mo.  It looks great on paper at a 10% rate of return or even at 6% dividend yields.  Unfortunately, reality and illustrations/spreadsheets aren't the same.  No one last 5-10 years doing this.  Just look at the S&P 10 year return. 

 

I liked the one poster that said to never invest money that can leave you homeless. 

 

I remember one investor doing this, buying Bombardier and Nortel shares in the year 2000 (they were tired of hearing of everyone else getting rich with these stocks) with their HELOC and then the investment going down a lot and then they doubled down.  In less than 3 short years they blew something that took them 20 odd years to accumulate.  Bottom line : Pretty good upside, devastating downside.  If the money you end up wanting to invest is more than 10-20% of your net worth, likely way too risky.  If you are worth $5M and you are borrowing $250k against your $1M mortgage free house, it is less risky.

[Myth465]

I liked the one poster that said to never invest money that can leave you homeless. 

 

I agree with this post here and also think FFHWatcher has some good rules regarding sizing.

 

The responses so far have been very interesting though. You guys wouldnt borrow at 3-4% if it were locked at that rate for 20 - 30 years. Perhaps the home is a bit much, would you guys do it on a none owner occupied investment property? I would, but I would tell anyone who asked me it was a bad idea, because most people are well most people.....

 

Also are you all completely debt free. I have student loan debt which I could pay off. The debt is at 3% and is still currently tax deductible. Why pay that off?

 

I guess the article is addressed to Joe and Jane and in that case its a really bad idea.

[oec2000]

What did Buffett say about the use of leverage?

 

If you are smart enough, you don't need it; if you are not, you have no business using it.

 

Still, it sound really tempting if you can lock it in for 30 years without the risk of recall! :)

[Myth465]

Watch what Buffett does not what he tells people to do inmo.

 

Buffett borrows from time to time (generally long term and when rates are low), and inmo Insurance float is a form of leverage and / or spread investing....

[oec2000]

Insurance float is a form of leverage and / or spread investing....

 

True, but there is a major difference in that he gets paid while borrowing the insurance float.

[Myth465]

Insurance float is a form of leverage and / or spread investing....

 

True, but there is a major difference in that he gets paid while borrowing the insurance float.

 

In good years ya, perhaps not this year though. What about him taking on leverage when rates were low during most downturns.

[CONeal]

Insurance float is a form of leverage and / or spread investing....

 

True, but there is a major difference in that he gets paid while borrowing the insurance float.

 

In good years ya, perhaps not this year though. What about him taking on leverage when rates were low during most downturns.

 

Insurance float is not available to the common investor so it doesn't matter what WB does.  He is a completely different ball of wax. 

[ragnarisapirate]

If anybody on here has a mortgage on their house, they are already effectively doing this if they have any common stock investments.

 

The things that Buffett says about leverage and many other things, are very broad sweeping, which as a rule of thumb, are good. However, there are times when rules are meant to be broken. When that time comes, he is smart enough to know what to do...

 

If you are confident in your ability, then, it might not be a bad idea. Then again, if it goes wrong, it could make you work a lot longer than you had thought, ruin your marriage, and maybe even result in the loss of your house (If you lose a job and the money that you invested).

 

It's all about risk and reward, people. :)

[ERICOPOLY]

If anybody on here has a mortgage on their house, they are already effectively doing this if they have any common stock investments.

 

Exactly.  Everyone has the choice to save money by prepaying some mortgage, holding cash, or buying some investments.  Somebody with no mortgage and no cash is the same as someone with a mortgage and stock investments that offset the mortgage.

 

The way we view it is left up to psychology  :)

 

Personally, I think it is lower risk to have the mortgage and the investments, rather than no mortgage and no cash or investments.  The scenario where you lose your job and need liquidity -- you can't tap your equity in your home when you have no job/income.  So my personal believe is that it's lower risk to tap the equity and buy investments -- this way you have at least some liquidity when you lose your job.

 

[Myth465]

 

Insurance float is not available to the common investor so it doesn't matter what WB does.  He is a completely different ball of wax.

 

It does when people quote or invoke his words in arguments, my basic point is Buffett tells Jane and Joe not to use leverage, but he himself has and does use leverage. Great advice for Joe and Jane though.  :).

 

If anybody on here has a mortgage on their house, they are already effectively doing this if they have any common stock investments.

 

The things that Buffett says about leverage and many other things, are very broad sweeping, which as a rule of thumb, are good. However, there are times when rules are meant to be broken. When that time comes, he is smart enough to know what to do...

 

If you are confident in your ability, then, it might not be a bad idea. Then again, if it goes wrong, it could make you work a lot longer than you had thought, ruin your marriage, and maybe even result in the loss of your house (If you lose a job and the money that you invested).

 

It's all about risk and reward, people. :)

 

This is what I dont get. Are people advocating paying off the house completely prior to investing in stocks?

[Cardboard]

I think that you have to be a good and experienced investor to make it worthwhile and that the loan amount needs to be reasonable vs your net worth.

 

You have to forget about yields matching or exceeding your loan cost and focus instead on great investments. Reaching for yield is the risk here.

 

Also, going all in is dumb IMO since you need at least a place to live and shouldn't risk that. Your family life could be hurt permanently if you screw up. At the same time, when I look at my portfolio, my house has the highest price to value ratio. Said differently, I figure that it can only appreciate by roughly the rate of inflation. It is a lot of capital being tied up at such a low rate, but should also be a good hedge against it. So I would not exceed 80% of the house value to stay with a conventional loan which is cheaper, but a lower percentage might be more appropriate depending on your volatility tolerance.

 

So I think that investing a portion of its value via a loan at FIXED rate is a good way to lower this cost of ownership (capital being tied up, municipal taxes, repairs, etc). I put emphasis on fixed since you want to remove this uncertainty from the equation. You can always borrow variable in your margin account so what is the point of saving a few basis points because you are giving your home as collateral? With a fixed rate, which is low because your home is given as collateral and being non-callable, you end up with a very attractive financing vehicle to invest. One issue with the structure, is that fixed rate loans require principal repayments monthly or otherwise, in Canada anyway. So you need to think about recurring amounts coming out of your brokerage account to pay them off. If you have a salary, it is likely less of an issue.

 

If you are interested at only making more money, the best option is to sell the house and to rent a 1 or 2 bedroom appartment. House utilities, taxes, maintenance, insurance and other costs will roughly match your rental cost and utilities. Then use the house proceeds to invest. That is roughly what I did in my early years. I did not need a house, so I figured that it was better to stay in an appartment which met most of my needs and to save the difference to invest. It worked out very well. You have to be disciplined however and to really save the difference. For most people, money burns a hole in their pocket so they are better off creating an obligation to at least save something aka mortgage.

 

Later on I bought a home and I am now strongly thinking about a loan against it to invest. Rates are so low, I can't borrow cheaper from any other source and I don't manage other people's money. So to create float it seems like my best option.

 

I figure that if society goes into really dark times and my investments all go to zero, that the worker who is barely able to pay for his house will likely lose his job and his house. I will have at least some equity left in the house. I could then take a small loan against what is left and buy guns, ammo and canned food.  ;) You need to be optimistic to use such strategy. So is Buffett with his levered structure which is Berkshire float (possibility for unlimited claims on limited premiums), so are fund managers with the always present possibility for massive redemptions. Here it is just yourself and Mr. Market being part of the equation.

 

Cardboard   

[Uccmal]

This is what I dont get. Are people advocating paying off the house completely prior to investing in stocks?

 

I dont think people are saying this.  What I am trying to get across is that borrowing extra with the intention of making it rich is too much risk.  Borrowing against your home to get 3% extra yield is what Prem refers to when he talks about reaching for yield. 

 

Many of us on this board are specialists at risk management whether we call it that or not.  Lay people that the Ric Edelmens of the world, and the 'advisees' FFHWatcher is referring to, are not. 

 

I use margin.  I am extremely careful and have alot of experience with it - 15 years.  I no longer write puts, or write calls, or anything else that is margin intensive - just common stock.  I am careful to ensure that the dividends cover the interest.  The nature of margin allocation is such that it can only be used on liquid stocks above $2.00, and not on derivatives.  These rules for margin were born out of experience by brokers over 100 years.  It tends to keep one within reasonable boaundaries.  Using a Heloc is too much like found money.

 

As with anything else there is one rule for those who truly know what they are doing and one rule for those who do not.  Munger borrowed huge amounts of money at times when he was in a sure thing (1 m once according to Alice S.).  But he would be the second to tell you to not use debt.  Buffett only used debt when he could sell long bonds at cheap rates.

[oec2000]

The irony is that those who don't need to use leverage are the ones who can most afford to use it.

 

If I have a $10m net worth, I can safely take a $1m HELOC against my home. If I have a net worth of only $0.2m, taking a $0.5m HELOC is much riskier.

[AZ_Value]

I think that you have to be a good and experienced investor to make it worthwhile and that the loan amount needs to be reasonable vs your net worth.

 

You have to forget about yields matching or exceeding your loan cost and focus instead on great investments. Reaching for yield is the risk here.

 

Also, going all in is dumb IMO since you need at least a place to live and shouldn't risk that. Your family life could be hurt permanently if you screw up.

 

Cardboard 

 

I think these points by Cardboard are exactly right on. The knee jerk reaction to the article that came from members of this board just has to do with the magnitude of what is being proposed rather than the essence of what is being proposed, i.e. it's the fact of risking the house your family lives in by leveraging it and not the fact of using debt per se. It's about what is reasonable and what is not in the context of your own financial situation.

 

Like Buffett said "Never risk what you have and need trying to get what you don't have and don't need" (I think he said this talking about the LTCM debacle and those geniuses that leveraged their fund to the sky trying to reach of extra yield.

 

As a side note I think it speaks to the quality of the board if so many here have the instinct to back away from a risky advice like this one, even though the math seems to work out in the sense of squeezing out some extra income, that extra income doesn't seem to be worth the risk for many here. I know it's not for me.