When interest rates are low, borrowing to invest can pay off. Whether you own your home or are still paying off a mortgage, you can apply for a home equity loan -- also called a second mortgage -- and start investing. Typically, the interest rate on this kind of loan is lower than other forms of credit, making it appealing to the savvy investor.
Know Your Budget
Before you get a home equity loan, consider your budget. You'll be making monthly payments, so your income has to cover those payments and any other expenses you have, like another mortgage, car payments and power bills. If you default on your second mortgage, though, you risk losing your home. For tax purposes, the IRS usually allows you to deduct interest on up to $100,000 worth of home equity loans.
Home equity loans often are used to fund home improvement projects. As a homeowner, you benefit from the renovations and your home's resale value increases. Unfortunately, most renovations don't recoup your entire investment. For example, according to Remodeling Magazine, the addition of a wooden deck recoups 96.1 percent of the investment in San Francisco California, but only 69.4 percent in Albany New York. Regionally, some renovations are more cost effective than others. Of course, these figures are averages, and you'll get more value out of renovating an old kitchen than a new one. Other renovations to consider include energy efficient upgrades like new insulation, siding and windows that can lower your power bills.
Investing in income property is a two-fold benefit. On the one hand, there is the rent from tenants, and on the other, the real estate itself can appreciate in value. This could mean taking out a mortgage on the property and using the equity from your residence home as a down payment. If done right, the tenant's rent covers the loan payments and leaves you with some return as well. Eventually, the equity built up in the income property can be further leveraged.
The money from a home equity loan doesn't need to be invested at a high rate of return to pay off. For example, given a 30-year, $50,000 home equity loan borrowed at 6 percent interest, if only the $250 interest is paid off each month, the total cost of the loan is $140,000. If you invest that $50,000 and get a conservative rate of return of 6 percent per year, with compounding interest, this grows to $287,000, doubling your investment. Lower interest on your loan, or higher interest on your investments further increase your return. Robert Powell of MarketWatch reports that many baby boomers are investing home equity in their 401(k) accounts to avoid paying taxes on their investment. No investment strategy is without risk, so consult a financial advisor about your options.
With an eclectic background, Ian Johnston has written on diverse topics including literature, real estate, executive leadership and mental health. He received an Master of Arts from The University of Western Ontario, and a Master of Education from The University of Ottawa. He lives in Dartmouth, Nova Scotia.