My bank recently approached me with opening a $250,000 Home Equity Line of Credit (HELOC) on my primary residence. The interest rate is 6.6 percent, and there are no closing costs unless I close the line within the next three years. The money can easily be transferred into my primary checking account via online banking.
Given that I have wanted another potential source for emergency cash, and given that there were no costs to me, I opened the HELOC notwithstanding the high interest rate. I could not get a clear explanation for the high rate – my credit score of 745 was apparently not enough to get a lower variable rate with my bank (I will likely do a separate post on this issue, because the seeming arbitrariness and imprecision of credit scores is something that has been irritating me for many years). It could have been the loan to value ratio, but the bank never confirmed this.
In any event, I opened the line intending to only use it for emergencies – it was basically free access to extra cash, with no real risk unless I actually use the money.
At closing I learned that I can borrow the entire $250,000 for 3.5 percent, as long as I pay the money back within the first year. When they told me about the lower rate, I gazed into the distance, and got dollar signs in my eyes. I immediately became convinced that I could borrow this money for one year, invest it elsewhere, earn a return greatly in excess of 3.5 percent, pay back the HELOC, and reap the investment returns.
Based on this new information, I have already arranged to take out $150,000, and use part of that to pay off some old student loans and other small debts. After I do this, there will still be roughly $100,000 remaining, on which I will owe 3.5 percent at the end of one year (end of January 2019). I have decided not to touch the other $100,000 and keep it in the HELOC, except for emergencies. Before the end of the year, I will pay off the $50,000 HELOC money that I am using to pay off debt.
So I have $100,000 borrowed at 3.5 percent, and I’d like to use that money to make some more money. However, it turns out that (at least for me), this is a harder scenario than one would think. My genius friends have variously suggested Vegas, penny stocks, Super Bowl parlays, and bitcoin (yes, I may be in the market for new friends :)). But what can/should I do with this money? Here are some options I have considered:
- Invest in high yield dividend stocks or REITS for one year, taking the risk that the asset price will drop over the next year. Assuming a 5 percent return, this will net 1.5 percent or $1,500 profit.
- Invest in short-term, hard money real estate loans at roughly 6.5 percent, taking the risk that the real estate market will turn south before the end of one year. Assuming the loans perform as expected, this option will net roughly 3 percent profit, or $3,000 for the year (note that this amount could be 1 to 4 percent higher if I invest in riskier loans, but the additional risk to “borrowed money” principal is too great in my mind).
- Use the money to leverage into favorably-valued residential rental properties, with the promise to myself that I will pay back the money before the end of the year. This option allows me to plant some more money into the ground earlier in the year if I find the deals, rather than waiting until the end of the year when I have extra cash (and possibly missing out on a good deal). This option comes with a relatively small maximum cost of $3,500 as long as I pay the money back within a year, which may make sense depending on the terms of the deal. Of course, to do this I would have to keep the money on the sidelines, perhaps just putting it back in the HELOC, with no promise that a deal will come along.
- Plow this money into index funds with the hope that the bull has one more year to run. This is the classic risk of borrowing money to chase leveraged returns in an overheated market. I would need to get a return in excess of 3.5 percent for this to be profitable. I’m not going to do this for many reasons, but it is theoretically an option for this money.
- Do nothing with the money. Put it back into the HELOC and don’t take any risks with it. Use the HELOC for its intended emergency purpose only, except to pay the $50,000 or so in debt (I reasonably expect that I can pay off that $50,000 by year end, and the debt I would pay off is currently financed at roughly 6.5 percent, so there would be an interest savings of roughly 3 percent of $50,000, which is about $1500). This option appeals to my risk-averse self, especially since this is my primary residence we are talking about.
- The most obvious thing to do with this money is retire higher-interest debt. Unfortunately (or maybe fortunately), I don’t have any other debt besides the $50,000 or so in debt I am already paying off, plus my first mortgage (which is 30 years at 3.25 percent).
- I could chase higher returns on a Realty Shares investment or something similar. My returns would be lower than normal for this kind of deal, because I would owe interest on the borrowed money. The teaser rate would essentially juice the overall lower returns a bit on those deals, but the fact that I would be using borrowed money means that I’d be taking on the risk of those deals without a commensurate high return. This probably is not an option because the whole point is to take advantage of very cheap money for one year, and most of these deals are for longer than one year.
Ultimately this whole idea boils down to using leverage, which in my mind only makes sense in a shorter term deal (to take advantage of the low rate for one year), for possibly very high returns. I don’t think the risk of hard money loans or high yield stocks is worth the relatively low return after paying the interest. Only a higher return deal would make sense, which probably means keeping the money in the HELOC and using it only if the right real estate deal comes along. I think this is what I am going to do.
What would you do? Have you faced a similar situation? As always, I appreciate your thoughts and comments. Happy investing!