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Using A Personal Loan To Invest: Is It Ever A Good Idea?

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Last updated on October 1, 2021

Are you considering taking out a personal loan to use the funds to invest? Is it ever a good idea to do so, or is it too large of a risk?

The only time it makes sense to use a loan to invest (also known as an “invest a loan”) is when the potential return of the investment is high, while still being low risk. For example, it’s not advisable to take out a loan to invest in cryptocurrencies, the stock market, or derivatives.

The problem is that there really aren’t many investment vehicles that fit into this category, considering that you also have to make enough to repay the principle of your loan.

If you take into account that personal loans are usually short fixed-term loans (less than 7 years) and also have high interest rates, it means the investment you make also has to be a high ROI delivered on a shorter term as well.

Are you even allowed to use a personal loan to invest?

When you get approved for a personal loan, the funds are yours to do as you wish. That means you’re free to invest the funds in any vehicle you wish.

So yes, you are allowed to use the funds received from a loan to invest.

Should you get a loan to invest?

This is where it gets tricky. The obvious answer is NO. Finding investment opportunities that are very low risk, while still having a high yield potential, are difficult. In most cases, you’ll be subjectively selecting investments and convincing yourself that the investment is low risk.

For example, many people could argue that Bitcoin is a relatively low risk investment. When analyzed year over year, the ROI curves are consistently up and to the right. But others would argue that it’s one of the riskiest investments you could get into, and using the funds to purchase Bitcoin is really just gambling.

Example: let’s say that you get approved for a personal loan with a low interest rate of 3%…

Unless you’re an expert investor who really knows what they’re doing, most investments are not going to be worth it.

Let’s say you invest in something that pays you back 10% return. If you never pay off your loan for a year, you’re up $1000 minus the 3% interest on the loan which comes out to $300. That means you made $700 for the year.

While that sounds nice, remember that you need to make monthly payments on the loan, so the principle investment keeps getting smaller as you use the funds to pay your loan payments. That means that you have to calculate for diminishing returns.

The return isn’t great enough to make the loan worth it, especially when you consider that there’s always a high chance that the investment tanks and you lose all your money and now have $10,000 in debt accruing interest each year.

Why do people get loans to invest?

The most common reason why people get loans to invest is usually because they see a “big opportunity” that they don’t have the funds to invest in themselves. In most cases, these are amateur decisions without the necessary due dilegence and proper state of mind.

Especially now that we’re living through the cryptocurrency boom and stories of people turning $10,000 into $10 million are constantly bombarding our news feeds, it’s understandable to get tempted.

Using a loan to invest in your business

Then there are the people who get loans to use the funds to invest in their business. While this is considered risky as well, it’s more sensible than just betting it all on Bitcoin.

Many people have used loans to invest in their businesses and have seen higher ROI’s than they would have gotten had they invested elsewhere.

Investing in your own business is a more sensible reason to take out a loan to invest.

Things to keep in mind

Personal loans have high interest. While many loans are advertised as low-interest (around 5.99% APR), most people don’t qualify for the lowest rates. This makes it harder to find an investment that you have high conviction will be worth much more than the loan you take on.

You have to make monthly payments. This is where a personal loan is not a great fit because you have to start repaying the loan almost immediately through fixed monthly payments. That means you’ll have to come up with the funds to pay the monthly payment, or sell a part of your investment each month.

Markets are impossible to predict. While a crazy bull market might bait you into believing that you can’t possibly lose money, things can change quickly and you could suddenly find yourself with a heavy loss on the investment and no way to pay off the principle loan, which will continue to keep accruing interest.

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