People take loans are taken for different reasons – Cars, Homes, Weddings, Education and even starting a business. But, should you use personal loans for investing?
One of the most important parts of finance and money altogether is smart management. We’re going answer one of the most interesting as well as controversial topics about personal finance – Should you use personal loans for investing?
If you’re considering taking a loan only for the sake of investing in stocks, then this article is for you.
Usually, people take debt for different reasons – For higher education, starting a business, buying a car or house, and so on. The list goes on and on.
The whole idea of taking on debt is to make an expensive and important purchase. Given how easy it is to access debt, some people had the creative idea of using loans to invest.
But how good of an idea is it to use leverage solely for investing? Let’s list the points to remember before using personal loans for investing and find out!
Should You Use Personal Loans For Investing – Things To Consider
Investing in itself is an activity that is done using additional or excess income. This extra income should not be confused with savings and emergency funds.
Also, if your goal is to make more money, then you should first consider reducing your present debt if you have any. The money you save after doing so could be then put into the markets.
If you are actively considering using personal loans to invest, then these are the things you need to keep in mind.
1. Interest Rates
Personal loans are unsecured loans. Loans are mainly of two types – secured and unsecured.
Secured loans are backed by an asset that is pledged by the borrower at the bank or NBFC. For example – In home loans, the property is the asset and it itself can be pledged to the bank.
In case of default in extreme situations, the bank will seize the asset to recover the issued loan. Personal loans belong to the 2nd category.
Unsecured loans have no assets to back the loan, which makes them risky to the bank. This is the main reason why personal loans have very high-interest rates.
If you are taking a personal loan for investing, then you have to be sure that your return on investment is well above the loan rate of interest.
Because of high-interest rates, even if your investment does extremely well, understand that a sizable portion of your returns will go back into repaying the loan.
But keep in mind that while your investment will face volatility, the banks will expect regular payments on the loan, irrespective of how your portfolio is performing.
2. Market Volatility
Volatility is what moves the markets every day. It’s through volatility that traders make money from the markets. While this is great news for traders, even they can go wrong.
If the stock does badly in the market, then you will be left with a huge debt that will burn a hole through your wallet.
Here, you’re left with a double negative – A stock that has lost most of its value and a high-interest personal loan. Lenders are indifferent to what borrowers do with the loan, as long as they receive their payments on time.
This being said, if you are sure about taking a personal loan for investing, make sure you have another income source as a backup to make regular EMI payments.
3. Investment Risk
A good stock, over time, can fetch substantial returns. In some cases, it has been known to double your investment over a long enough period.
But veteran investors know the flip side of the coin as well. Even fundamentally good stocks can fall badly in the market, and nothing can be done to avoid it.
When bear markets set in, it can take years for the economy to recover. In that time, interest rates could climb, making that personal loan even more expensive, while your investment takes years to recover.
4. Chance Of Defaulting
If you’re using a personal loan to invest, it’s just the tip of the iceberg. Underneath, you have multiple factors to consider before making a decision.
One of those factors is defaulting on the loan. While missing a few EMIs may not seem like a big deal, it will hit your CIBIL score in the long run.
Also, credit rating agencies keep track of your data, so these financial issues can have a Domino effect on your credit history.
This will affect your ability to apply for a loan for the rest of your life. Keep in mind that defaulting on your loan might be forgiven by the bank or NBFC, but it will make any future applications for a loan highly unsuccessful.
5. Investment Period
Imagine you make an investment with a 5-year time horizon. To your good fortune, you achieved your profits within 2 years, cutting your investment horizon short by a full 3 years.
This is an optimistic scenario. On the flip side, if your investment horizon is delayed by a few years, you would have no choice but to wait.
This is also possible provided your investment was through extra/additional income. But if it was through a personal loan, completely dependent on the profits for debt repayment, this would be a different scenario.
Be prepared to endure loss-making periods, but also have a backup plan to repay the personal loan.
The markets are indifferent and unforgiving. The stocks will not rise out of pity because a few investors decided to use debt for investment.
They do not care if you have a loan payment coming up. As a thumb rule, do not use personal loans to invest, especially if you have no other way of repaying the loan.
If you are keen on becoming an investor, you can consider clearing off present debt, if any, and educating yourself about the markets.
That’s all for the article Should You Use Personal Loans For Investing, We hope you enjoyed reading it.
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