If you own a house, you probably receive the same junk mail that stinks up my mailbox. The aim of these junk mailers often is to wheedle you into refinancing your house. Whether or not people are reading these unwanted solicitations, plenty of homeowners have taken advantage of low-interest rates to refinance their home loans or obtain equity credit lines.
This column, however, isn't going to explore the pros and cons of refinancing. What I'm interested in examining today is what all too many people are doing with their money after they've refinanced.
An increasing number of flush homeowners are pillaging their home equity to place bets in the stock market. With a sizable stash of money to play around with, they hope to emulate Warren Buffett or perhaps Jim Cramer, the hyperkinetic host of a CNBC stock trading show. These investors hope they can make profits on their homesteads by capturing returns that dwarf the rate they're paying on their borrowed money.
People who play the market by risking their houses are more common than you may imagine. A study conducted by the Federal Reserve Board determined that 11 percent of the cash freed up through mortgage refinancing was used to invest in the market. Researchers examined a period from 2001 to the first half of 2002, but a strong argument could be made that the percentage is now higher because of the strength of the refinancing boom and soaring home values.
The Federal Reserve documented that homeowners weren't as tempted to stray into the markets just a few years earlier. From 1998 to the first half of 1999, less than 2 percent of the cashed-out equity ended up in the stock market.
It's not hard to think of reasons why you should avoid exchanging your home equity for a pile of poker chips. When investors are under pressure to generate a fat return that will justify their risky venture, they are often more inclined to assume greater risks. They may sink the money into investments that are the equivalent of sticks of dynamite with faulty fuses. Sure, riskier investments offer the potential of greater rewards, but they can also explode and obliterate your financial security.
What some gamblers also might not realize is this: When you use home equity to buy stocks, bonds or other securities, you are investing with borrowed cash. It's like purchasing stocks on margin. Yes, your buying power is greatly enhanced, but so is your risk.
Of course, leveraged borrowing leads to the ultimate reason that this strategy is flawed: If you stumble, you could lose your house. The NASD, the securities industry regulator that issued a warning on this practice, provided an example of the trouble you can face.