Should you use personal loans for investing?
It could be a good idea, but make sure the return will be higher than the APR
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While most personal loan lenders specifically prohibit the use of loan funds for investing, there are a few that allow it. You can borrow funds, invest them, pay off the loan with the proceeds of your investment and potentially make a profit.
But while it might seem like a good idea to borrow money so you can invest more, there are some massive risks that can actually cause you to lose money.
- Investing a personal loan is risky, but if you can earn more than you pay in interest, it can be worth it.
- It’s important to read the terms and conditions of your personal loan so you don’t violate them and risk facing penalties.
- If you can’t afford the loan payments yourself and are relying on investment returns, you should avoid using a personal loan for investment purposes.
Is investing a personal loan legal?
There are different types of loans that can be used to purchase assets and investments. For example, auto loans and home mortgages are used to purchase vehicles and homes, as the loan is secured to the asset itself as collateral.
Personal loans are unsecured loans that can be used for almost anything, including investing or purchasing assets. You borrow a set amount, select your repayment terms and make monthly interest and principal payments to pay it back over time.
While there is no explicit law in place preventing borrowers from using personal loan funds for investment purposes, some lenders prohibit certain activities, including investing.
For example, Upgrade and SoFi don’t let you use personal loan funds for investing and include this in the terms and conditions of the loan when you apply. In fact, if you say you’ll be using the personal loan to invest, you will be rejected for the loan altogether.
But some personal loan companies do not have these restrictions. Companies like LendingPoint allow you to borrow up to $25,000 and have no restrictions on using the loan for investing.
» COMPARE: Best personal loans
When does it make sense to invest a personal loan?
Investing a personal loan might be a good idea if you believe that you can earn a greater return on a low-risk investment than the interest rate on your loan. For example, if you can get a personal loan with a fixed 5% annual percentage rate (APR), and can invest the funds to get an 8% return with little risk, then you can earn a 3% profit per year.
John Grace, a financial advisor and founder of Investor's Advantage Corporation, says there are a few circumstances when it could make sense to use a personal loan to invest.
“Investing a personal loan can make sense in certain scenarios,” said Grace. “For instance, if you secure a low-interest personal loan and plan to invest in a high-return opportunity, the potential gains could outweigh the loan interest.”
Here are a few circumstances when it might make sense to invest a personal loan:
- Risk is low
- When there is very little risk that an investment can lose money, it is considered low risk. Investments such as high-yield savings accounts, certificates of deposit (CDs), and U.S. Treasurys are considered low-risk investments. On the contrary, investing in the stock market or real estate is considered a higher-risk investment, and would not make a good investment choice for personal loan funds.
When borrowing funds to invest, consider your personal risk tolerance. How much volatility can you tolerate with your investments? You must also be in a financial position to handle losing your invested funds while still being able to pay back your personal loan.
- Return on investment is high
- Before investing borrowed funds, make sure you won’t be losing money. The investment needs to deliver a higher return than the interest rate on your personal loan.
The problem is that high returns are typically paired with high risks. Be certain you can handle the risks associated with your investment.
- APR is low
- Personal loans typically have higher interest rates as they are unsecured and not tied to an asset. To get the lowest APR, you need a high income, low debt-to-income ratio (DTI) and a high credit score. Online lenders typically offer the lowest rates as they have low overhead and can provide funding completely online.
With a low rate, you can have low payments while attempting to invest and earn a higher return.
- You’ve done your research
- “If you have an existing investment portfolio with a solid track record and a clear strategy, using a personal loan to enhance your portfolio diversification might be considered,” said Grace.
Do your research. Compare online lenders to find the lowest rate possible. Make sure you can handle the monthly payments. And research your investment to ensure it will provide a high return with low risk.
When is it a bad idea to invest a personal loan?
“Investing a personal loan becomes a bad idea when you're taking on high-interest debt to fund speculative investments or risky ventures,” said Grace.
“If the investment's returns are uncertain or volatile, you could find yourself in a situation where the investment's value doesn't cover the loan repayment. Moreover, relying on borrowed funds to invest can amplify your losses if the investment doesn't perform as expected. Avoid investing borrowed money in a get-rich-quick scheme or highly leveraged investments, as the consequences of losses could be financially devastating.”
Investing with a personal loan is a type of leveraged investing strategy that should be reserved for more advanced investors. While the profits could be multiplied, so could the losses.
Here are a few reasons to avoid investing a personal loan:
- The lender prohibits it. If your lender explicitly prohibits investing loan funds, you should not do it. If the lender discovers you have violated its terms and conditions, it may demand immediate repayment (with interest).
- You can’t afford to lose on the investment. If you can’t afford to lose money on the investment you make with the loan funds, it’s too risky to use a personal loan to invest.
- You don’t have excellent credit. If you don’t have excellent credit, you probably won’t get a low enough interest rate on your personal loan to make a profit on your investment.
- You can’t repay the loan without investment profit. If you intended to use the investment’s profit to repay the loan, but the investment underperforms, you may not be able to make the loan payments. This can cause significant damage to your credit score and you might end up in debt.
» MORE: What is a good investment?
Pros and cons of using personal loans for investing
Investing a personal loan can be a good idea, but it’s also very risky. Here are a few pros and cons of using personal loans for investing:
- A personal loan may allow you to make a larger investment than your savings permit.
- If your loan interest rate is low and your investment return is high, you can earn a profit.
- Repaying a personal loan can help you improve your credit score.
- Most lenders explicitly prohibit using loan funds to invest.
- Most investments don’t provide a fixed rate of return, which can increase risk.
- If you already have debt balances, taking out a personal loan can increase your DTI and lower your credit score.
Can personal loans be used for anything?
Personal loans can be used for nearly anything, including consolidating debt, home improvement, vacations, paying for a wedding or buying a vehicle. Most lenders do restrict certain activities for personal loans, including paying for college, making a down payment on a home, gambling or illegal activities. But restrictions will vary by lender, so check the terms and conditions before applying for a personal loan.
What happens if you default on a personal loan?
If you default on a personal loan, you can be hit with fees and penalties and eventually sent to collections. And it can hurt your credit score severely. If the loan is sent to collections, the collections company may garnish your wages or place a lien on an asset you own (such as your home).
What are the safest investments?
There are several investments that are considered safe, including high-yield savings accounts, CDs, Series I Savings Bonds, money market funds, and U.S. Treasurys.
When is the best time to invest?
The best time to invest is after doing your research, setting aside funds for investing and having a plan in place. While timing the market may seem like a good idea, it’s best to consistently invest in quality assets for a long period of time.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
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