cash out refinance and index fund

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argonautI
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cash out refinance and index fund

Post by argonautI »

Hi,

With current interest rate being this low, I have wondered if it is ever worth doing a cash out refinance and investing the extra cash in lump sum in index fund (sp500, total market or even QQQ). My assumption is that you will be hold the loan and pay it off no longer than 5 years. It seems tempting. The math seems like you may come out ahead, but maybe I'm just fooling myself.
placeholder
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Re: cash out refinance and index fund

Post by placeholder »

I did exactly that some years back when rates were low and it worked great but the hue and cry here will be against it.
lakpr
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Re: cash out refinance and index fund

Post by lakpr »

Make sure you adjust for taxes. Cash out refinances are not eligible as itemized deductions, unless you use the money to improve the home. With the purpose you are stating, a 3% interest rate in the 22% bracket is equivalent to 3% / (1 - 22%) = 3.84% taxable equivalent yield. This is the base return rate you must earn on your investments before you take the plunge. Often, the expected return should be substantially higher.

Still low enough, highly possible that you will exceed that with your investments, but crucially, that outcome is not guaranteed. Just want you to be aware that you should not simply use the nominal interest rates for your break even comparison
invest4
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Re: cash out refinance and index fund

Post by invest4 »

This approach may make sense, but perhaps more or less so depending upon you individual circumstances and goals.

How much are we talking about and it’s size relative to your existing investments? How far away are you from retirement? Is it important for you to have a paid off house at some point?
Topic Author
argonautI
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Re: cash out refinance and index fund

Post by argonautI »

lakpr wrote: Tue May 18, 2021 2:06 am Make sure you adjust for taxes. Cash out refinances are not eligible as itemized deductions, unless you use the money to improve the home. With the purpose you are stating, a 3% interest rate in the 22% bracket is equivalent to 3% / (1 - 22%) = 3.84% taxable equivalent yield. This is the base return rate you must earn on your investments before you take the plunge. Often, the expected return should be substantially higher.

Still low enough, highly possible that you will exceed that with your investments, but crucially, that outcome is not guaranteed. Just want you to be aware that you should not simply use the nominal interest rates for your break even comparison
Thanks. It seems complicated what you are suggesting. I was thinking of something simple for comparison as follows:

Let's assume you get a lump sum cash out of $100K with interest rate of 3.5%. If you amortize this over 10 years, it comes out to about $12,024 each year with interest. Assume market return is 7%. You can see that it is equivalent to you putting in $12,024/year over time into the market. At the end, lump sum is better and gets better the longer you hold it. Am I looking at this wrong?

Code: Select all

lump sum return          	borrowing return               
year 1	100000		   	12024	12865
year 2	107000		   	12024	26631
year 3	114490		   	12024	41361
year 4	122504		   	12024	57122
year 5	131079		   	12024	73987
year 6	140255		   	12024	92031
year 7	150073		   	12024	111339
year 8	160578		   	12024	131999
year 9 	171818		   	12024	154104
year 10	183845		   	12024	177758
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camillus
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Re: cash out refinance and index fund

Post by camillus »

Why don't you compare this to a margin loan?
51% US / 34% ex-US / 15% “bond”
lakpr
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Re: cash out refinance and index fund

Post by lakpr »

argonautI wrote: Sat May 22, 2021 6:56 pm Thanks. It seems complicated what you are suggesting. I was thinking of something simple for comparison as follows:
<<snipped for brevity>>
If your assumed rate of return is 7%, which is higher than the 3.84% that I calculated in my previous post, of course investing wins. Either with lumpsum or dollar cost averaging.

You are also not wrong that the lumpsum investing is better than dollar cost averaging, especially when the returns are always positive as stated in your assumption. With dollar cost averaging, with each subsequent investment you get lesser benefit (so only the first installment gets the full 10 year 7% growth, the next installment gets only 9 years of 7% growth, the next installment gets only 8 years of 7% growth, etc.). With lumpsum, of course you get the full 10 years growth on the entire $100k.

In any case, my previous reply is *NOT* meant to be a decision on DCA vs LS investing. It is meant to caution you that, whatever investments you will make, you need to cross the threshold of 3.84% base return, just to break even, on an annual basis. With stocks, probably you can. In fact a very high likelihood that it will. But, to repeat my words from previous post -- NOT GUARANTEED. Your $100k might become $80k in year 3 due to market losses. You will wish you had not put your home on the line for investment in the market then ...

Remember, the even of markets going down is not an IF; it is WHEN. There will be downturns, and there will be upturns. That's why if your investment horizon is less than 5 years, the money should not be in the stock market at all. Between 5 and 10 years, coin flip, or temper your risk with some addition of bonds. Only if the investment horizon is more than 10 years it should be invested in equities.
flyingcows
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Re: cash out refinance and index fund

Post by flyingcows »

argonautI wrote: Tue May 18, 2021 12:30 am Hi,

With current interest rate being this low, I have wondered if it is ever worth doing a cash out refinance and investing the extra cash in lump sum in index fund (sp500, total market or even QQQ). My assumption is that you will be hold the loan and pay it off no longer than 5 years. It seems tempting. The math seems like you may come out ahead, but maybe I'm just fooling myself.
What math would that be? After taxes, maybe your index will beat the return of your loan, or maybe not
Ron Ronnerson
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Re: cash out refinance and index fund

Post by Ron Ronnerson »

lakpr wrote: Tue May 18, 2021 2:06 am Make sure you adjust for taxes. Cash out refinances are not eligible as itemized deductions, unless you use the money to improve the home. With the purpose you are stating, a 3% interest rate in the 22% bracket is equivalent to 3% / (1 - 22%) = 3.84% taxable equivalent yield. This is the base return rate you must earn on your investments before you take the plunge. Often, the expected return should be substantially higher.

Still low enough, highly possible that you will exceed that with your investments, but crucially, that outcome is not guaranteed. Just want you to be aware that you should not simply use the nominal interest rates for your break even comparison
This is exactly how I look at it.

OP: There is risk involved in taking cash out from a home and putting it in the stock market whereas paying down a fixed-rate mortgage gives you a guaranteed rate of return. So first you have to understand that the risk level is not the same and you would be taking a chance if you invested the money. Also, you must factor in taxes on any earnings. Additionally, 7% growth is sort of optimistic in my opinion. 10 years is a relatively short amount of time and returns could be much less than that, perhaps even negative.

The tax bracket is crucial in all this in order to see how much you would need to earn to make the cash-out refi worthwhile. Since you don't provide it, I'm going to assume it is 22% federal and 8% state (so we can get a nice and even combined rate of 30%). If the mortgage rate is at 3.5%, you need to earn 5% on the money you take out after factoring in taxes just to break even (3.5%/0.7=5%). You may be able to pull it off but it is anything but a guarantee, particularly over only 10 years.

I recently did a cash-out refi but my numbers are more favorable than the ones you used in your example. I took out $150k on a 30-year refi at a rate of 2.375% (effective rate is about 2.28% due to itemizing on state taxes). I'm in the 12% federal bracket and don't pay any state income tax. So my calculation is 2.28%/0.88 = 2.59%. I am hopeful that I can beat that over 30 years.

I'm actually down a little bit so far, which shows that scoring 7% like clockwork is anything but guaranteed. On the positive, I tax-loss harvested and figure I got plenty of time to recover the little bit I'm down so far. Also, my home is not going to be paid off now until I'm in my mid-70s. I'm expecting a $100k/year pension, though, so making payments after retiring is less of a concern.

If I had to beat 5% in 10 years to break even, I really wouldn't bother trying.
BamBamBam
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Re: cash out refinance and index fund

Post by BamBamBam »

Ron Ronnerson wrote: Sat May 22, 2021 7:48 pm.

If I had to beat 5% in 10 years to break even, I really wouldn't bother trying.

Ron- why the pessimistic view? How often does the market not beat 5% in 10 years? Honest question.
lakpr
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Re: cash out refinance and index fund

Post by lakpr »

BamBamBam wrote: Sat May 22, 2021 9:09 pm
Ron Ronnerson wrote: Sat May 22, 2021 7:48 pm.

If I had to beat 5% in 10 years to break even, I really wouldn't bother trying.

Ron- why the pessimistic view? How often does the market not beat 5% in 10 years? Honest question.
1999 to 2009. Dividend reinvestment included.

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BamBamBam
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Re: cash out refinance and index fund

Post by BamBamBam »

Thanks for the link. So pay down the mortgage for guaranteed return- any other options in your opinion?
lakpr
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Re: cash out refinance and index fund

Post by lakpr »

BamBamBam wrote: Sat May 22, 2021 10:13 pm Thanks for the link. So pay down the mortgage for guaranteed return- any other options in your opinion?
Buying I bonds. For now.
Ron Ronnerson
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Re: cash out refinance and index fund

Post by Ron Ronnerson »

BamBamBam wrote: Sat May 22, 2021 9:09 pm
Ron Ronnerson wrote: Sat May 22, 2021 7:48 pm.

If I had to beat 5% in 10 years to break even, I really wouldn't bother trying.

Ron- why the pessimistic view? How often does the market not beat 5% in 10 years? Honest question.
I should clarify that I do expect the stock market to beat 5% over most 10-year periods. However, if I had a timeframe as little as that, I wouldn’t take money out of my house to take that chance. I don’t necessarily think it’s a bad bet to make; I just said I “wouldn’t bother.” My thinking is that even if you do earn a bit above 5% on $100k over 10 years, how much have you really gained when the first 5% of the return just gets you to the break-even point? Also, this outcome isn’t guaranteed. On top of that, having a paid-off home can be useful for a lot of people as they get older.

The more you increase the timeframe beyond 10 years and decrease the return needed to break even, the more I’d personally be interested in a cash-out refi for investing purposes. For example, if you’re talking about 15 years and needing to beat 4%, I could see that as a solid move. If you’re talking about 20 years or more and needing to do better than just 3%, I’d want to sign up. I'm specifically talking about taking cash out to invest here. There can be other reasons to take cash out as well. In my case with the recent refi, I was primarily seeking greater liquidity though I did invest a portion that I don't think I will need for a while.
Topic Author
argonautI
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Re: cash out refinance and index fund

Post by argonautI »

camillus wrote: Sat May 22, 2021 7:08 pm Why don't you compare this to a margin loan?
I looked at that too, but margin rates are just not as favorable in comparison to cash out refinance. You will be gambling with a tight margin. It will probably not be worth it.
Topic Author
argonautI
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Re: cash out refinance and index fund

Post by argonautI »

Ron Ronnerson wrote: Sat May 22, 2021 10:25 pm
BamBamBam wrote: Sat May 22, 2021 9:09 pm
Ron Ronnerson wrote: Sat May 22, 2021 7:48 pm.

If I had to beat 5% in 10 years to break even, I really wouldn't bother trying.

Ron- why the pessimistic view? How often does the market not beat 5% in 10 years? Honest question.
I should clarify that I do expect the stock market to beat 5% over most 10-year periods. However, if I had a timeframe as little as that, I wouldn’t take money out of my house to take that chance. I don’t necessarily think it’s a bad bet to make; I just said I “wouldn’t bother.” My thinking is that even if you do earn a bit above 5% on $100k over 10 years, how much have you really gained when the first 5% of the return just gets you to the break-even point? Also, this outcome isn’t guaranteed. On top of that, having a paid-off home can be useful for a lot of people as they get older.

The more you increase the timeframe beyond 10 years and decrease the return needed to break even, the more I’d personally be interested in a cash-out refi for investing purposes. For example, if you’re talking about 15 years and needing to beat 4%, I could see that as a solid move. If you’re talking about 20 years or more and needing to do better than just 3%, I’d want to sign up. I'm specifically talking about taking cash out to invest here. There can be other reasons to take cash out as well. In my case with the recent refi, I was primarily seeking greater liquidity though I did invest a portion that I don't think I will need for a while.
I choose 10 year because I thought that will be a realistic amount of time I may stay in my current house. Of course, I can never be sure. If you plan on staying in your current house for next 30 years, thenn you have an extremely high probability you will come out ahead using cash refinance with lump sum index fund.
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grabiner
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Re: cash out refinance and index fund

Post by grabiner »

Before you decide how to borrow, you need to decide whether borrowing more money makes sense.

First, you should already be 100% stock before you consider borrowing more money to buy more stock. Otherwise, you lose less interest by selling your bond funds than you would pay by borrowing money.

Next, you need to be confident of your risk tolerance. Was all your money in stock in March 2020, and did you say at the time, "It's a great time to buy more stock; I wish I had more?" And what did you do in 2008-2009, if you held stock back then?

Only then can you decide whether a cash-out refinance, a margin loan, or buying leveraged stock funds is the best way to take the extra risk.
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SteadyOne
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Re: cash out refinance and index fund

Post by SteadyOne »

Ron Ronnerson wrote: Sat May 22, 2021 10:25 pm
BamBamBam wrote: Sat May 22, 2021 9:09 pm
Ron Ronnerson wrote: Sat May 22, 2021 7:48 pm.

If I had to beat 5% in 10 years to break even, I really wouldn't bother trying.

Ron- why the pessimistic view? How often does the market not beat 5% in 10 years? Honest question.
I should clarify that I do expect the stock market to beat 5% over most 10-year periods. However, if I had a timeframe as little as that, I wouldn’t take money out of my house to take that chance. I don’t necessarily think it’s a bad bet to make; I just said I “wouldn’t bother.” My thinking is that even if you do earn a bit above 5% on $100k over 10 years, how much have you really gained when the first 5% of the return just gets you to the break-even point? Also, this outcome isn’t guaranteed. On top of that, having a paid-off home can be useful for a lot of people as they get older.

The more you increase the timeframe beyond 10 years and decrease the return needed to break even, the more I’d personally be interested in a cash-out refi for investing purposes. For example, if you’re talking about 15 years and needing to beat 4%, I could see that as a solid move. If you’re talking about 20 years or more and needing to do better than just 3%, I’d want to sign up. I'm specifically talking about taking cash out to invest here. There can be other reasons to take cash out as well. In my case with the recent refi, I was primarily seeking greater liquidity though I did invest a portion that I don't think I will need for a while.
Just one thing to keep in mind that mortgage lenders as a rule have a right to call a loan if they conclude that borrowers misrepresented themselves as to the purpose of the loan. They especially sensitive to using cash out moneys to buy other properties, not sure about index funds.
“Every de­duc­tion is al­lowed as a mat­ter of leg­isla­tive grace.” US Federal Court
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NewMoneyMustBeSmart
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Re: cash out refinance and index fund

Post by NewMoneyMustBeSmart »

argonautI wrote: Tue May 18, 2021 12:30 am Hi,

With current interest rate being this low, I have wondered if it is ever worth doing a cash out refinance and investing the extra cash in lump sum in index fund (sp500, total market or even QQQ). My assumption is that you will be hold the loan and pay it off no longer than 5 years. It seems tempting. The math seems like you may come out ahead, but maybe I'm just fooling myself.
My understanding is that if you borrow money and use that money to invest, the interest on that money can be deducted as an investment expense.

In this case, if it is so, then one can deduct the interest expense against your dividends and interest as I understand it.

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grabiner
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Re: cash out refinance and index fund

Post by grabiner »

NewMoneyMustBeSmart wrote: Sun May 23, 2021 5:15 pm
argonautI wrote: Tue May 18, 2021 12:30 am Hi,

With current interest rate being this low, I have wondered if it is ever worth doing a cash out refinance and investing the extra cash in lump sum in index fund (sp500, total market or even QQQ). My assumption is that you will be hold the loan and pay it off no longer than 5 years. It seems tempting. The math seems like you may come out ahead, but maybe I'm just fooling myself.
My understanding is that if you borrow money and use that money to invest, the interest on that money can be deducted as an investment expense.

In this case, if it is so, then one can deduct the interest expense against your dividends and interest as I understand it.
However, if you have qualified dividends and treat them as non-qualified in order to deduct more interest, you give up their tax advantage
Wiki David Grabiner
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Re: cash out refinance and index fund

Post by calwatch »

I wrote a check on the HELOC almost immediately after the COVID freefall last year, to hedge against the risk that the line of credit would close on me. I put the money in corporate bonds, since they were implicitly backed by the Fed, and gradually have shifted that over to putting that amount towards broad based stock index funds and high yield bond funds.

I do deduct the interest on the HELOC by offsetting my investment income, of which I usually have plenty from savings accounts, new account bonuses, and bond fund distributions. There is interest rate risk as the HELOC is an ARM, but I figure if interest rates shoot up dramatically (looking at prime rate history from the 2008 global financial crisis, it took years for the prime rate to recover), I would use my I Bonds to pay off the HELOC if it made financial sense.
Ron Ronnerson
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Re: cash out refinance and index fund

Post by Ron Ronnerson »

SteadyOne wrote: Sun May 23, 2021 5:05 pm
Ron Ronnerson wrote: Sat May 22, 2021 10:25 pm
BamBamBam wrote: Sat May 22, 2021 9:09 pm
Ron Ronnerson wrote: Sat May 22, 2021 7:48 pm.

If I had to beat 5% in 10 years to break even, I really wouldn't bother trying.

Ron- why the pessimistic view? How often does the market not beat 5% in 10 years? Honest question.
I should clarify that I do expect the stock market to beat 5% over most 10-year periods. However, if I had a timeframe as little as that, I wouldn’t take money out of my house to take that chance. I don’t necessarily think it’s a bad bet to make; I just said I “wouldn’t bother.” My thinking is that even if you do earn a bit above 5% on $100k over 10 years, how much have you really gained when the first 5% of the return just gets you to the break-even point? Also, this outcome isn’t guaranteed. On top of that, having a paid-off home can be useful for a lot of people as they get older.

The more you increase the timeframe beyond 10 years and decrease the return needed to break even, the more I’d personally be interested in a cash-out refi for investing purposes. For example, if you’re talking about 15 years and needing to beat 4%, I could see that as a solid move. If you’re talking about 20 years or more and needing to do better than just 3%, I’d want to sign up. I'm specifically talking about taking cash out to invest here. There can be other reasons to take cash out as well. In my case with the recent refi, I was primarily seeking greater liquidity though I did invest a portion that I don't think I will need for a while.
Just one thing to keep in mind that mortgage lenders as a rule have a right to call a loan if they conclude that borrowers misrepresented themselves as to the purpose of the loan. They especially sensitive to using cash out moneys to buy other properties, not sure about index funds.
I was straight-forward with the lender about the reason for the cash-out. I said that I intended to invest it and that's what I've proceeded to do. Roughly $30k of the funds will go into Roth IRAs for the years 2020-2022 (2020 contributions have been made with the funds already) and I put about $40k into a taxable account. It's all invested in index funds. The rest is in cash and I'm slowly deploying it in an effort to earn an after-tax rate of return greater than my mortgage rate. I have been using some of the cash to churn bank accounts offering bonuses and also putting small amounts into a variety of banks that offer a return above my mortgage rate. For example, there are some credit unions that offer 3% or more on a limited amount of money. If inflation rises in the years ahead, these efforts may become a bit easier. Anyway, I'm not buying any other properties.
dukeblue219
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Re: cash out refinance and index fund

Post by dukeblue219 »

Why so many threads about borrowing money to invest in stocks?

This is going to end badly. Maybe not for OP or the others recently, but for the broader economy it has NEVER been a good sign when average investors are leveraging up to buy stocks.

As for the apparent similarity between investing a cash out refi and investing while holding a mortgage, the difference is psychological. People who directly borrowed to invest are going to see it differently when money they had in hand goes away; the tendency will be to panic when the market drops. One who invests whole paying down a mortgage on schedule isn't going to panic and pull money out at the worst moment.
SteadyOne
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Re: cash out refinance and index fund

Post by SteadyOne »

dukeblue219 wrote: Sun May 23, 2021 7:14 pm Why so many threads about borrowing money to invest in stocks?

This is going to end badly. Maybe not for OP or the others recently, but for the broader economy it has NEVER been a good sign when average investors are leveraging up to buy stocks.

As for the apparent similarity between investing a cash out refi and investing while holding a mortgage, the difference is psychological. People who directly borrowed to invest are going to see it differently when money they had in hand goes away; the tendency will be to panic when the market drops. One who invests whole paying down a mortgage on schedule isn't going to panic and pull money out at the worst moment.
In some moments of history it actually worked well: in hyperinflation scenario like in Weimar Germany, mortgage
lenders desperately lobbied government to index existing long term mortgages because fixed interest on their mortgage became a tiny fraction of real interest rates. One story in the well known book “When money dies” describes how one fellow bought a huge farm with long term mortgage and then paid off his entire loan a year later with moneys he made by selling few buckets of potatoes from one of the fields. Similar with German stock market at the time. Bottom like it depends if inflation expectations of a speculator are correct.

If numbers go against you and rates collapse and stock market goes down big time, you may lose. However, having an option to refi is golden in this scenario
“Every de­duc­tion is al­lowed as a mat­ter of leg­isla­tive grace.” US Federal Court
MarbleC
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Re: cash out refinance and index fund

Post by MarbleC »

Seems likely to return more over the long term, but don't overestimate your appetite for risk.

The way I think about it is that it doesn't make sense to borrow money for investing if I'm already holding cash in my EF. I think I have a fairly high risk tolerance, but I still wouldn't liquidate my EF to buy equities and so I think it follows that borrowing money to put in equities is also outside of my risk tolerance.

Just some food for thought.
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