Rabbi Shamai Friedman got an interesting call from a mortgage broker. The fellow suggested that Shamai refinance and use the $200,000 in unlocked home equity to invest in stocks or an investment property. Rates were very low, so it shouldn’t be hard to earn considerably more than the additional interest payments required to cover the much larger mortgage. While doubling his mortgage seemed frightening, Shamai saw the logic in the broker’s pitch. As a rebbi with a limited salary, he’d never had the opportunity to invest.

Was refinancing his home his ticket to building some wealth?

Mixed Feelings

I have mixed feelings about this question, posed to me by multiple friends recently. Borrowing to invest seems very compelling when mortgage rates are so low and investment returns are strong. Purely from an investment perspective, using stable mortgage debt to leverage your finances makes a lot of sense. Borrowing $200,000 at, say, 3% to invest at 8% produces $10,000 annually ($200,000 x 5%, i.e. what’s left from the 8% after paying 3% interest). With compound interest, this profit would equal more than $125,000 over just 10 years, obviously a substantial sum for almost any family, especially a rebbi’s.

Not So Simple

Using mortgages to invest is aleph-beis to professional investors. But I’m a bit leery when this path is pursued by novices, especially when the debt is placed on a family’s home. Not all investments work out—it takes some effort to find properly secured growth opportunities. And even excellent investments can experience negative cash flows for months or even years. (The 5% projected profit also doesn’t account for loan amortization.) How will a rebbi cover this huge mortgage when income that he’s counting on doesn’t appear? Relying on volatile long-term investments to cover an ongoing monthly mortgage obligation is risky.

Risking Peace of Mind

Now, this risk of falling short on cash flow can be controlled by keeping ample cash reserves and implementing astute investment management. Again, investors do this all the time. And home mortgages offer the lowest rates, longest repayment schedules, plus multiple protections to shield borrowers if things get messy. But even many sophisticated investors hesitate to burden their personal homes with investment debt. There’s significant peace of mind when one’s home carries minimal or no debt. Should a rebbi or other middle-income earner forgo this peace of mind?

For an Only Shot

On the other hand, can a rebbi or other middle-income earner afford not to invest their home equity? The professional investor or high earner has the luxury of relying on other assets besides their home to earn extra income and grow wealth. For most others, their home is their only significant asset. Perhaps it would be prudent for them to take a bit of risk to have a better shot at paying for weddings or earning some added income. While maintaining a large mortgage is scary, so is the burden of supporting a family with insufficient salaries.

Proceeding With Caution

There’s merit to both sides of this argument, and therefore, it’s difficult to say that one position is right or wrong. Should someone decide to invest with borrowed money, they need to be extra careful with due diligence and managing their cash flow. Keeping significant reserves toward covering the mortgage during times when stock prices fall or an investment property is vacant is crucial. Also, while a homeowner may be able to borrow up to 80% or even more of their property’s value, they can be more conservative too. Borrowing to invest doesn’t have to be an all-or-nothing proposition.

Mortgages? Maybe. Margin? No!

My guarded interest about using debt to buy investments is bolstered by the amazing structures offered for residential mortgages. As noted, the low rates and easy terms required for housing debt in the USA are wildly advantageous from a borrower’s perspective. I’m much more skeptical about using other forms of debt to invest. This includes credit cards, hard money, and margin loans secured by stock portfolios and leveraged options. While these loans aren’t endangering the family home directly, they can easily destroy wealth and financial futures. The amateur investor is playing with fire when tapping into these tools in an effort to turbocharge returns.

Life Insurance Loans

I’m not a life insurance pro but have friends that are. A number of them mentioned their concerns about everyday people taking out loans against their life insurance policies (specifically premium finance or investing insurance loan proceeds). Similar to the roof over your head, life insurance is primarily about security and safety, not maximizing profits. While borrowing against life insurance to invest can make sense in some scenarios for the savvy and informed, doing so casually is a big mistake. Protection and profit are generally best kept separate.

Seichel is Required Too

On a bigger-picture scale, one thing that makes no sense is borrowing to invest and thereby losing eligibility for government assistance and tax credits that a family may need to stay afloat. Investing comes with risk. Investing creates tax issues. Investing takes insight. While there are many good reasons to try and get off social assistance, the numbers have to add up and common sense must be utilized. If in the pursuit of possibly earning $10,000, Rabbi Friedman will forgo an equal or greater sum of definite help from Uncle Sam, it’s clearly an unwise risk.

Debt as the Power Tool

Debt has helped create many fortunes. Rare is the millionaire who hasn’t used loans to accelerate their money-making capabilities. An analogy I’ve used before is that debt is like a power tool. Similar to motorized saws, drills, or hammers, properly handled loans can build your financial “house” much quicker than manual tools. But a leveraged error will certainly cost an arm or a leg!