By Jennifer Openshaw, CBS.Marketwatch.com       

LOS ANGELES (CBS.MW) -- Ever thought of borrowing against the equity in your home to invest in the stock market? The NASD is wagging its finger about that practice. In fact, it issued a warning to brokers this month saying it's not appropriate for most investors. See column on dangers of home-equity lending.

But how about using funds from a loan or line of credit against the equity in your home to invest in real estate?

Home-equity loans or lines of credit (HELOCs) are typically used to make home improvements or pay off debt. But they could make a lot of sense to boost your real estate portfolio, as Deborah Honeck found out after she left her job as a Silicon Valley executive to become a real estate investor.

That's because the tax deduction on a home-equity loan or HELOC can make the cost of your money extremely low -- as low as about 2.4%, based on a HELOC rate of 3.4% for those with the best credit, according to Bankrate.com. And you can have a ready source of funds without tapping other savings or investments you'd rather leave untouched. Finally, the opportunity to leverage your investment in real estate with a small down payment can result in returns much greater than the stock market.

Today, Honeck owns real estate worth just over $1 million, grown from an initial investment in 1998 of $57,000. If Honeck were to sell today, she would generate a 600 percent return on her initial investment over six years, before sales commission and taxes. This is an average rate of return of 100 percent per year, triple the 30 percent return that venture capital firms anticipate per year on an individual venture investment, according to a recent Joint Economic Committee study.

"I didn't expect to achieve that high a return on my investments," says Honeck. "The nice real estate appreciation we've seen in the Bay Area over the last five years certainly helped."

Honeck's strategy was successful -- so successful in fact that she decided to leave her profession as a Silicon Valley high-tech product manager and become a mortgage broker. Honeck now tries to help people replicate her success at Mortgage Magic, www.mortgagemagic.com, a San Jose based mortgage firm. See her firm's Web site.

Honeck was a pioneer in 2002, when only about six percent of people took out HELOCs to purchase property, according to the Consumer Bankers Association Home Equity Lending study. The idea is clearly catching on: the study indicates that today 22 percent of new HELOCs or home-equity loans are taken out to purchase property.

Honeck's story

In August 1998, Honeck got tired of renting small places at high prices. So, against the advice of well-meaning friends, she sold her technology stock and set herself the goal of homeownership by year-end. In November, Honeck found a house she loved for $290,000: a 1,600 square foot, 3-bedroom, 2-bath Eichler-designed home in San Jose, Calif.

Two years later, Honeck's decisions looked like genius as the technology stock market fell and the job market dried up. After Honeck was laid off from her job in Mountain View, she took a job in San Francisco and found that the hour-long commute left her with little time to do anything but eat and sleep. The job market was shaky, but Honeck had another inspired and unconventional thought.

"I crunched the numbers and realized that I could afford to own a home closer to San Francisco, if I could get a HELOC to use as a down payment," Honeck recalls.

Honeck started looking in Alameda and fell in love with a Victorian carriage house built in 1895. She decided to take out a $100,000 HELOC on her San Jose home and put $70,000 down on the Alameda home, which she purchased for $350,000 in 2002. It's now worth nearly $500,000.

Experts recommend caution

Borrowing against your home to invest is like leverage upon leverage, and it's not for everyone.

Jason Schwab, president of Schwab Financial Group Inc., a Los Angeles-based mortgage and business-management company, says taking out a HELOC to invest in the stock market is a bad idea.

"I never recommend that my clients take out a HELOC to invest in the stock market," says Schwab. "You don't take money from a safe investment and put it into a riskier one."

But Schwab agrees that taking out a HELOC to invest in another piece of real estate "is a similar investment type and makes sense for some clients."

Weigh the risks

Schwab elaborates on the risks involved in investing in real estate with funds from a HELOC:

Market risk: The property may decrease, rather than increase, in value, particularly in high-cost states like California and New York. In this case, it could take years for it to return to its original market value.

No renter/bad renter risk: No renter equals no monthly rent check at a time when two mortgages are due. A bad tenant who does not pay the mortgage or damages the rental could put you in the red.

Rate risk: Home-equity loans offer fixed rates but HELOC's do not. When the prime rate rises, the rate on a HELOC typically does as well.

Unforeseen property expenses: Houses, like anything else, need repair and maintenance. Plan on getting hit by high repair bills now and then.

Steps to take

If you think you are ready to take the plunge, consider taking the following steps:

Self assess: Write down your objectives for purchasing rental property and how you would manage the risks involved. If you cannot manage the risks, including loss of tenants, then the strategy may not be right for you.

Apply for a HELOC: Once approved for a HELOC, you know how much cash you have to invest, make improvements or use for emergencies. Be aware of possible annual fees on your HELOC.

Talk to professionals: Talk to your accountant, a financial planner and a real estate agent. The more you learn, the better informed you'll be on everything from taxes to property valuation to market rental rates.

Research the property: Take a look at rental and property appreciation trends in the area. You're betting that the property will appreciate, so assess the property and its risks very carefully.

Plan for cash flow: Be sure to conduct a cash-flow projection. Be prepared both for the possible loss of tenants and the rise in interest rates, as well as any investments needed to upgrade the property. Know whether you plan to hold the property for the long-term and what your ultimate goal is, such as to generate cash flow or to sell it upon appreciation.

Honeck now has a HELOC on both of her properties.

"I now have a HELOC on my Alameda property in case of unforeseen expenses or in the event the perfect property comes along," she says.

If you're at all uncertain about whether to use a loan or HELOC to make your real estate investment, be sure to talk to a financial adviser.