Should I do a cash-out refinance to fund my investments?

If you’ve been in your house for a while, you likely have built up some equity — the difference between what you still owe on your current mortgage and your home’s value. You can use equity for practically anything, including funding stock purchases or other investments.

When the stock market is doing well and mortgage interest rates are low, you may wonder if refinancing and pulling the equity out of your home to invest in stocks is a wise choice. Investing can pay off, but it’s also inherently risky.

So, when is a cash-out refinance to fund your investments a good strategy, and when is it a mistake? Let’s look at things to consider.

• What's a cash-out refinance, and how does it work?
• Withdrawing home equity to invest
• Pros and cons of a cash-out refinance to invest
• Should you use home equity to fund investments?
• What to do with your equity instead
• Other ways to invest

What’s a cash-out refinance, and how does it work?

Cash-out refinancing turns the equity you have in your home into cash. It replaces your existing mortgage loan with a new one for a larger amount than what you currently owe, and lets you pocket the difference between the two balances in cash — less any closing costs.

A cash-out refinance has two main benefits. It turns the equity you have in your home into cash, and your new mortgage loan could come with a lower interest rate, a lower monthly payment or possibly both.

Withdrawing home equity to invest

In the second quarter of 2021, 51% of homeowners chose a cash-out refinance, up from 38% during the first quarter of 2021, according to a Freddie Mac report. When you withdraw the equity built up in your home, you can use it for anything you want.

You can use the extra cash to pay for an unexpected emergency, pay down debt or fund home improvements to add value to your home. You can put the cash toward starting a new business or buying a second home. You can even buy stocks with the proceeds from your cash-out refinance.

Using equity to buy stocks

More than half of all households have some investment in the stock market, according to Pew Research. When mortgage interest rates are low, or the stock market is booming, using the equity in your home to fund an investment could be lucrative. But investing in the stock market also comes with risks, including rising interest rates, taxes and fluctuations in the economy.

Investing in stocks can be profitable, but comes with no guarantee of gains. It’s possible you could invest your equity and lose your entire investment. And remember, while your investments may generate money, you’ll also be paying interest on the home equity you borrowed.

Using equity to buy an investment property

Whether you want to buy a second home or an investment property to rent out and generate income, using the equity from a cash-out refinance can save you from dipping into your savings to fund the purchase. Because real estate tends to see less erratic swings than the stock market, your investment property will likely gain in value over time, with less risk of your investment losing value.

And while it’s easier to buy stocks than real estate, there are more potential tax benefits from investing in real estate.

Pros and cons of a cash-out refinance to invest

Despite all the benefits, a cash-out refi isn’t always the best option if you need extra money to invest. Plus, depending on the type of investing you want to do, the pros and cons will likely vary.

Pros

• You may have considerable equity built up in your home, which can mean access to a significant amount of money to invest.
• A cash-out refinance may offer a lower interest rate than a home equity loan or home equity line of credit (HELOC).
• You may be able to lower your monthly payments, giving you extra cash each month to invest.
• You may be able to take advantage of the mortgage interest deduction on a cash-out refinance if you use some of the money to buy, build or make substantial improvements and renovations to your home.

Cons

• Fees and closing costs can be high, possibly as much as 5% of your total loan amount.
• It can take 30 to 60 days or more to get your money from a cash-out refinance, which means you may miss out on your investment opportunity.
• Investing in stocks is risky, and you could lose the amount of equity you invested.
• If you can’t make your new mortgage payments, you risk foreclosure. Generally, it can take a long time to see a profit on your investment.

Should you use home equity to fund investments?

When you invest, it’s important to remember that most people make their money in the long term, not overnight. If you have retirement and emergency funds set aside for a rainy day, the stock market can turn a profit on the money you invest.

However, a cash-out refinance to fund stock purchases is rarely a good idea for most homeowners. Here’s why:

• The stock market is volatile. Since the start of the coronavirus pandemic, the stock market has experienced a series of dips and rises.
• The stock market is a long game. The stock market is best for patient investors, typically delivering returns over the long term. Markets can fluctuate quickly, and you can lose money overnight. It can take years to recover losses.
• There’s no guarantee of returns. Investing is an inherently risky endeavor. A positive return on your investment is never guaranteed. And even if your investments grow, you’ll still be paying interest on the equity you borrowed.
• Replacing a sure thing with risk. Investing your home’s equity in the stock market puts that money at risk. Leaving equity in your home is generally safer.
• The stock market is complicated. Buying individual stocks is complex and nuanced. The average homeowner may not have the knowledge necessary to invest in the stock market and see a positive return.

What to do with your equity instead

Investing in the stock market is far from the only way to put your equity to work for you. Here are some others:

• Fund home improvements, repairs or renovations. Home improvement projects and home renovations can add value to your home. Whether revamping your kitchen or adding a new deck or windows, when it comes to selling your home, you may find the right extras add big equity.
• Pay off or consolidate higher-interest debt. A cash-out refinance might offer a lower interest rate than many credit cards or high-interest loans. Consolidating your debt can also lower your monthly payments and may even raise your credit score. But keep in mind your home could be at risk if you fail to make the payments on your new mortgage.
• Build or add to an emergency fund. Unexpected emergencies happen. If you fear a hospital stay or a major home repair will drain your savings, using the equity built up in your home to start or add to an emergency fund can ensure you’re in a safe place.
• Make a large purchase. Maybe you’ve been saving for some time to make a large purchase but still can’t seem to scrape together the money you’ll need to see it happen. Tapping into the equity in your home may be the answer. Just be sure to weigh the pros and cons of tapping equity for a big purchase.
• Pay for school. You can use a cash-out refinance to help fund your child's education, or to further your own degree, increasing your income for years to come.

Other ways to invest

Investing is one of the best ways to grow your money — if done responsibly. No matter your age, income or career, many investments may be less risky than buying individual stocks:

• Mutual funds — If you’re saving for a long-term goal or retirement, mutual funds offer an inexpensive way to invest while also limiting the chance of loss, because your money is spread across multiple investments.
• IRAs — You can set up an IRA at your bank, credit union or other financial institution. It allows you to save for retirement on a tax-free or tax-deferred basis.
• 401(k) — An employer-sponsored 401(k) is a retirement savings plan that offers tax advantages to the investor. Generally, a portion of your paycheck, which may be matched by your employer, is paid directly into an investment account. You won’t be taxed on the gains until you withdraw the money from the account.
• CDs — Certificates of deposit (CDs) are federally insured savings accounts that offer a fixed interest rate over a specific period of time, usually one, three or five years. But if you withdraw your money early, you’ll likely pay a fee.
• Real estate — Investing in real estate can provide a passive income stream. It does require more money and time than investing in the stock market, but it can also be less risky.
• High-yield savings accounts — High-yield savings accounts provide a higher rate of return than standard savings accounts. Since withdrawals are limited to six per month, savings accounts are best if you only need to access your money occasionally.