Why You Shouldnt Take Out A Personal Loan To Invest
A personal loan is a relatively small, unsecured installment loan that you pay back at a fixed rate over a period of three to seven years . You usually dont need to put up collateral, but youre required to make a monthly payment until youve fully repaid the loan plus interest. If you dont, you risk damaging your credit score. Personal loan amounts often range between $10,000and $100,000, though some lenders also offer smaller loan amounts.
With investing, theres very little guaranteed. The money you put into the market could go up in value, or it could go down. You could even lose it all.
That difference makes using a personal loan for investing inherently risky, and usually a bad idea. In fact, some personal loan lenders even specifically prohibit you from using the money for investing. Here are a few other reasons why you might shy away from using a personal loan to invest:
When Does A Personal Loan For Investing Not Make Sense
There are a lot of risks involved with this method, even if taking out a personal loan to invest can be advantageous in some circumstances.
Risk cannot be avoided because none of us can make accurate predictions. Therefore, effectively managing it is essential to successful investing.
As you have to deal with interest rates and debt payments, borrowing money to invest is particularly risky. Following are three reasons why taking out a personal loan to support your investing journey may not be a smart move:
Whats Next: Take Stock Of Your Situation Before You Borrow To Invest
Now that you understand both the advantages and disadvantages of using a personal loan for investing, its important to apply them to your specific situation.
To start, youll want to get an idea of what current interest rates look like, particularly for your credit situation. Many personal loan lenders allow you to get prequalified before you submit an application, so you can view loan offers without a hard credit check.
This process can help you determine which lender may give you the best interest rate. If your credit needs some work, take time to build your credit before you continue.
Even if you can get a low interest rate, though, youll need to think about how averse you are to risk. If youre worried about losing money on your investment and the consequences that ensue, it may not be worth it. But if you generally have a low aversion to risk with investing, think about how much you can afford in both the best and worst-case scenarios.
Finally, its important to make an honest assessment of your experience with investing. Its easy to get caught up in the excitement over a particular investment opportunity, and you may worry about missing out on big gains.
But if you dont have a lot of experience or expertise with this particular opportunity or investing in general, you may be better off waiting and developing some experience before you take such a big risk.
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When It Makes More Sense To Do Something Else
Investing the cash from a personal loan may not be the best way to maximize the value you can get from it. In some cases, using the funds from a personal loan to consolidate higher-interest credit card or other debt actually nets you more money via savings.
For example, consider a credit card balance of $3,000 with an APR of 15 percent . If you can shop around for a personal loan that works for you and get approved for one with 6 percent APR, you can save a lot of money while paying off your debt.
- If you make payments of $100 a month on a credit card with a $3,000 balance and 15 percent interest, you’ll pay in total $3,783.57.
- If you make payments of $100 a month on a personal loan of $3,000 with an APR of 6 percent, you’ll pay in total $3,258.56.
- That’s a savings of more than $500.
Aside from the ability to save money, one of the benefits of using a personal loan to consolidate debt is that you’re more likely to get the financial value you expect. All you have to do is hold up your end of the “bargain” by making the appropriate payments on your personal loan. As long as the terms and math line up in your favor, you will benefit from the savings.
You don’t get the same guarantee when you’re investing. You can do everything correctly and still not come out ahead when you’re playing the stock market. So, it’s a good idea to avoid taking out personal loans to invest unless you’re very sure about the opportunity.
When Is It A Bad Idea To Use Personal Loans For Investing
If you took the above steps before using a personal loan to invest, then you probably made a smart financial move . But there are some red flags when it comes to taking out a personal loan for this purpose.
If any of these points apply to you, then you shouldn’t take out a personal loan to invest:
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When Does It Make Sense To Borrow Money For Investing
Does it make sense to borrow money to invest? Were not in favour of it, but were going to look at the common reasons why people borrow money to invest. Its important to remind you that borrowing money to invest for any reason is extremely risky, and you should consult a financial professional before making a decision.
Can I Get A Heloc On An Investment Property
A HELOC is a revolving line of credit secured by the borrowers equity in a property. Typically, the borrower doesnt need to begin making payments until theyve started spending money similar to a credit card.
By taking out a HELOC on an investment property, you may be able to pay for improvements to your property or finance personal debts like school expenses or medical bills.
Keep in mind that investment property HELOCs are generally considered riskier for lenders than HELOCs for primary homes, so your rate will likely be higher. If youre in the market for a HELOC on your investment property, youll find fewer options available.
For example, Boeing Employees Credit Union offers HELOCs for primary, secondary and vacation homes as well as investment and rental properties but each has a different APR. A HELOC on a primary residence has the lowest starting rate, while a HELOC for an investment property has the highest starting rate.
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You Have A Lower Risk Tolerance
Investments arent risk-free and some are riskier than others. If youre taking on debt to invest in the market, you have to be reasonably sure that your investment will pay off. In the meantime, you have to be comfortable with the risk that involves.
The stock market moves in cycles, and volatility can affect stock prices from day to day. So its good to understand how you typically react to volatility and what level of risk is acceptable to you before taking out a personal loan.
If the idea of being stuck with a loan for an investment that doesnt pan out isnt something you can stomach, then it may not be right for you.
Likewise, you may want to take a pass on a personal loan if youd be investing in something that you dont fully understand or havent thoroughly researched.
Can I Get A Personal Loan For Investing
Personal loans are among the most versatile types of loans because you can often use the funds for just about anything you want.
However, some lenders may have restrictions on how you can use the money you receive. For example, you may not be able to use the money to start a business or consolidate student loan debt. Its generally possible to take out a personal loan and invest the funds in the stock market, mutual funds or other assets, but some lenders may prohibit you from doing so.
Among popular online lenders, SoFi, LightStream and Upgrade explicitly exclude investing as an acceptable way to use your personal loan funds.
Before you apply for a loan, its important to shop around and compare multiple options. During that process, contact each lender and ask about limitations on how you can use the loan funds.
If you get a personal loan and the lender has explicitly prohibited using the loan funds for investing, doing so would put you in violation of the loan agreement. If that occurs, you could be forced to pay back the full debt immediately.
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Good Debt May Help You Avoid Bad Outcomes
Mook relates the story of a client who owed a large tax payment on April 15, well before June when he was expecting to receive a cash payment. The client could have sold off some assets in his portfolio to pay the tax bill, but that would have required reconstructing his portfolio afterward, not to mention paying transaction costs and potentially more taxes. Instead, the client decided to take out a loan to pay the tax bill and then repaid the loan in June. âAvoiding disruption in your portfolio is an example of using debt effectively,â explains Mook.
You may want to consider using income generated from diversified investments to pay down bad debts. After assessing the amount of your bad debts, you may find that it makes financial sense to sell off an asset to quickly pay down your debts. This is where your personal debt tolerance comes in.
Good Debt May Help You Accomplish Your Objectives
Student loans are probably the most common example of good debt, given the correlation between a college degree and higher earnings throughout your career.3 But thatâs just the start. âGood debt can help borrowers accomplish an objective or help them avoid a bad outcome,â says Mook.
When it comes to accomplishing your objectives, consider another common example of good debt: taking out a mortgage on a new house. For most people, itâs not possible to pay for a house outright. However, even if you were able to pay for it in one large payment, there are benefits to taking on debt for a home. Paying down a mortgage results in equity in a home as well as potential tax advantages. Plus, if you know youâll be able to make your monthly payment, there is the additional benefit of improving your credit score by making the payments consistently.
Depending on your circumstances and risk tolerance, leveraged investing can be another good debt strategy. Say youâre investing $100 with an expected 10% rate of return. If you invested your own money, you would earn $10. But if you were to invest half your money and borrow for the other half, you could earn more, if the interest on the loan is less than 10%. In this example, says Mook, âyou leveraged your return.â
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Your Income Or Expenses Could Change
Taking out a personal loan means youre committing to repaying that money. While you might be able to afford the payments now, that may not be true if your income or expenses change down the line.
Something investors might not like to think about, but is a risk, is what if the market doesnt perform favorably? What happens if there is a loss on the investment and you have to find other funds to make the personal loan payments? Its a good idea to have a backup plan because even if the investment doesnt provide the return thats expected, the lender will still expect payments on that personal loan.
Before applying for a personal loan, ask yourself whether youd still be able to keep up with the payments if your income were to decrease, your other expenses were to go up, or the investment didnt see the return you thought it would.
If you dont have an emergency fund in place, for instance, how would you manage the loan payments? Would you have to sell the investments you made to make a loan payment? Could you borrow money from friends or family?
Thinking about these kinds of contingencies can help you decide if a personal loan for investing is the best way to go.
Leveraging Home Equity Line Of Credit To Invest
Using funds from a home equity line of credit to invest would give you access to a significantly larger sum of money since the equity in your home secures the funds. Of course, that also increases your risk since your home could be at stake if you cant make the interest payments.
If you arent disciplined about paying back the money you withdraw from your HELOC, you could end up paying more in total interest over time, even if your rate is low.
Borrowing and investing a larger sum of money might make it psychologically harder for you to stay invested if theres a market downturn. For example, a 20% annual market loss on a $10,000 investment is $2,000, but the same percentage loss on a $100,000 investment is $20,000. And that loss may feel even more acute when you add the fact that your investment may be worth less than the outstanding debt on your HELOC.
To recap, leveraging your HELOC to invest could be a smart strategy if you:
- Have a lot to gain through interest tax deductions.
- Are confident youll be able to make your interest payments with ease and have a plan to pay back the principal
- Plan to invest for at least 10 years and stay in the market even if you experience sizable annual losses.
- Understand that your home is at risk so you cant be using this money on speculative assets.
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You Dont Qualify For The Best Rates
When using personal loans for investing, the math becomes important since any interest you pay has to be justified by the returns you earn. Even if youre investing in something that youre sure is going to result in a sizable gain, you still have to consider whether the interest fits in.
If you dont have great credit then any returns you realize may be overshadowed by the interest youre paying to the lender. The total interest cost increases the longer you pay on the loan, which is also something to keep in mind if youre considering a two-year, three-year, or even five-year repayment term.
Before applying for a personal loan, its helpful to check your credit reports and scores to see where you stand.
This can help you gauge what type of interest rates youre most likely to qualify for if you do decide to go ahead with a loan.
Using A Personal Loan To Invest Is A Risky Proposition And There Are Only A Few Circumstances Where It Can Make Sense
In most cases, its a bad idea to use a personal loan to invest. Learn why.
Investing is a great way to grow your net worth and meet financial goals. You can often earn much more with your money by putting it in the stock market instead of keeping it in a savings account. Over the long term, the stock market offers a roughly 10% annual rate of return, compared with 1% or less in a high-yield savings account.
If youre looking to increase the amount youre investing, you may consider taking out a personal loan to add to your investment account. But this is rarely a good idea.
Heres why you generally shouldnt take out a personal loan to invest, as well as a few instances when it might make sense.
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Youre Increasing Your Income
Many people boost their monthly income by turning their hobbies and passion projects into side hustles or small businesses. If youre looking to launch your own side venture, a personal loan could offer the funding you need to get started
Using a personal loan to invest in a side hustle or increase your income can be a wise investment if you take the time to develop a sound business plan and ensure you have thought through how you will generate income and pay back the loan.
It may be easier to qualify for a personal loan to invest in a passion project than it would be to qualify for a business loan. Before taking this approach, however, its a good idea to review all of your funding options and find the choice that will be the most cost-effective, including finding the option that will charge the least interest and most favorable repayment terms for your financial needs.
You Have Excellent Credit
Your is one of the biggest factors that influence how much borrowing a personal loan will cost you. If you have anexcellent credit score for example, a FICO score of 800-plus you have a better chance of qualifying for a lenderslowest interest rate, and you might not lose as much of your investment.
When you qualify for the most competitive interest rates, you will pay less interest over the life of the loanmeaning borrowing the money will cost you far less and thus is less of a risk.
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