Are you comfortable going into debt for an investment that may fluctuate in value? Can you afford to lose the collateral you put up for a personal loan? Any asset used as collateral, including your home, can be taken by the creditor to satisfy the loan. How will you pay for the loan if your investmentsfall in value?
Borrowing to buy investments can be an effective way to boost your potential returns. This is called using leverage. As long as your investment increases at a rate that is higher than your borrowing costs, you can make money. But taking on debt involves more risk than paying for an investment outright with cash.
- Scrutinize the loan rates
The number of Americans choosing a personal loan to fill in some sort of money gap is on the rise, thanks in part to falling interest rates in the past 2 years. But obtaining a loan requires a little advanced preparation to get the best terms.
Before you start snapping up stocks, you’ll need to find out what kind of interest rate your lender is offering. Earning high returns on your investments won’t do any good if you have to hand a big chunk of it back to the bank.
The only time it makes sense to borrow money for an investment – known in financial lingo as “invest a loan” – is when the return on investment of the loan is high and the risk level of the investment is low. It is inadvisable for an investor to invest a loan in a risky vehicle, like the stock market or derivatives. Also, if an investor takes out a loan, it does not make sense to place the money in an investment that will mature after the loan is due. It is also important that the investor makes sure that the return on investment is greater than the cost of the loan.
- Assess your payment methods
Ideally, if you’re taking out a loan to invest the goal is to have returns rolling in on a regular basis that you can use to repay what you borrowed. If you’re taking a long-term buy-and-hold approach to investing, you might be waiting a bit longer to realize any gains. If that’s the case, it’s important to make sure you can afford the loan payments in the meantime.
That’s particularly important if you have other debts you’re paying down, such as student loans Opens a New Window. or a mortgage. If you fall behind on your personal loan payments, you can open yourself up to a world of financial trouble. The lender could seize your collateral or sue you and if they win, your wages could be garnished.
In the worst-case scenario, you might have to file bankruptcy to get out of the mess. So you’ll need to be sure your loan payments aren’t going to put you in a financial bind.
- Do your research
Jumping into the stock market without doing your research isn’t a good idea, especially when you’re doing it with borrowed money. If you’ve got your eye on a particular stock or mutual fund, you’ll need to look at how it has performed since its inception date, not just over the last few months.
Just because a stock is doing well right now doesn’t mean it’ll perform well in six months. If you’re not careful, you could end up losing money. And even an investment with solid past performance isn’t guaranteed to perform in the future.
- Assess your personal risk tolerance
If you pay any attention to the news at all, then you probably know that the market can change in the blink of an eye. If you’re thinking of using a loan to invest, how well will you stomach the market’s ups and downs? Some people can take on more risk to have the possibility of bigger rewards but if you’re not one of them, borrowing to invest might be outside of your comfort zone.
- Evaluate the fees
Along with charging interest, lenders might impose certain fees when you get a fast cash loan. Even if it’s just a few dollars a month, every nickel and dime counts in terms of eating into your investment returns.
Aside from the lender’s fees, you’ll also have to think about what the investment itself is going to cost. If you’re buying stocks through an online broker, for instance, you might have to pay a trade commission every time you complete a transaction. Mutual funds carry their own management fees that you’ll need to watch out for as well.
Investing is simple but not easy
“The most important decision you can make with respect to investing is the decision to start,” said Johnson.
While you might not be able to invest very much today, it’s worth getting started. As your finances improve and you free up more money in your budget, you can increase your contributions and see even better results.