An interesting article on “equity stripping” appeared in MortgageNewsDaily.com earlier this year. The article was a follow-up to a Jane Bryant Quinn piece in Newsweek. Equity stripping refers to the practice of taking out a HELOC loan - stripping the equity from the homeowner’s investment - for purposes of investing in another asset class such as stocks. Despite the fact that most financial advisors (and the NASD) recommend against it, in 2002, an estimated 11% of HELOC borrowings were used for stock market or other investments.

MortgageNewsDaily.com says equity stripping may “be a sensible investment strategy” and plans to revisit the subject. It will be interesting to hear what they have to say.

My own sense is that using home equity proceeds for investing should be done cautiously and only by those with sound understanding of the investment alternative they are pursuing. For many homeowners (maybe most), it isn’t a good idea - particularly if pursued with a “this can make me rich” mindset.

But taking out home equity to buy the latest model plasma TV or to consolidate credit card debt (without modifying spending habits) aren’t great ideas either; yet this is exactly what people are doing day in and day out.

If you were to rank the “worst-to-best” possible things to do with your home equity on a scale of 1 to 10, I would score a well-thought out, prudent investment strategy at least a 7.

Liquidating one asset to invest in another (hopefully appreciating) asset category can be prudent and has benefits - including diversification. No investor should fall into the trap of keeping their assets in one basket - including the homestead basket. The challenge with investing home equity is finding an investment that appreciates or produces an income stream at least equal to the interest cost of the equity borrowing without assuming added risk. With the solid research (and expert assistance if needed), it is doable.

Here are some thoughts on when equity stripping may be a sensible strategy:

• where a person is financially secure (with assets other than his or her home) and in position to repay the HELOC in the event of a meltdown. HELOCs have the benefit of being extremely convenient and hold advantages over broker margin borrowing.

• where the amount allocated to investing is relatively small (e.g. LTV <20%)>

• where a safe, fixed-income arbitrage opportunity presents itself. For example, introductory HELOC “teaser-rates” that last for 6 - 24 months can often be leveraged by investing HELOC funds in a higher-yielding CD of comparable maturity.

• where there is concern that home values may drop (”housing bubble”?). Moving equity to another investment category in a declining housing market could be a very wise move.

• where retirement accounts are not adequately funded. For example, it may be sensible to strip home equity for this purpose particularly if the alternative is to not fund and miss out on a generous 50% - 100% employer match. This strategy can be particularly attractive if you plan to sell you home with a few years.

Much of the concern about equity-stripping no doubt comes from a CYA mentality among financial advisors and regulators. No doubt there are good practical and legal reasons to remind everyone of the risks. Yet most personal success stories are ultimately based on the willingness to assume significant financial risk.

Typically, home equity stripping involves taking out accumulated equity to invest. Another more risky angle discussed at Sound Money Tips is to pledge investment securities in lieu of the traditional downpayment on a home purchase.

Here’s a link to the NASD press release outlining concerns with equity stripping.