Whether you’re planning for a large purchase or paying for an emergency home repair, a personal loan is a helpful tool. Since funds can be used for nearly any purchase, you might be considering using personal loans for investing.
Taking out a personal loan and investing it might seem like a foolproof way to build your wealth. However, though it might be an option, using personal loans for investing carries serious risks.
When is it a good idea to take out a personal loan to invest?
In some scenarios, it may be worth using your personal loan for investing. This could be the case if:
- You’re investing in career advancement. In some professions, earning a promotion or getting a more lucrative job offer might require a special certification or professional license. Borrowing a loan as an investment in your career might make sense if it increases your chances of earning a competitive income. Check the U.S. Bureau of Labor Statistics’ Occupational Outlook Handbook to learn more about job growth projections and median salaries in your field.
- You’re increasing your income. Many people boost their monthly income by turning their hobbies and passion projects into side hustles or small businesses. If you’re looking to launch your own side venture, a personal loan could offer the funding you need to get started.
- You have excellent credit. Your credit score is one of the biggest factors that influences how much borrowing a personal loan will cost you. If you have an excellent credit score — for example, a FICO score of 800-plus — you have a better chance of qualifying for a lender’s lowest interest rate, and you might not lose as much of your investment.
- You can afford the monthly payment. Consider whether you feel financially comfortable making the loan’s monthly payment, regardless of how your investment performs. Make sure to factor in any existing debt you’re repaying now and other goals you’re saving toward (e.g., saving up for a home). If you still feel confident about your ability to repay the loan, this might be an option for you.
When is it a bad idea to take out a personal loan to invest?
You should carefully consider not just the pros but also the cons of using a personal loan for something like investing. Here are some scenarios where doing so might be the wrong move:
- The investment is considered risky. When an investment has a higher-than-average chance of underperforming or offers above-average returns in a short period, it’s considered a high-risk investment. Investing in the stock market, for example, is considered very risky. Adding debt to your investment portfolio makes your investment strategy more volatile overall.
- You don’t have strong credit. If you don’t have excellent credit, you won’t qualify for a lender’s lowest advertised loan rate. With some personal loan rates as high as 35.99 percent APR, the cost of the loan might be more than your potential investment return. To see your credit score from all three bureaus at no cost, visit AnnualCreditReport.com.
- You can’t afford to have the investment fail. If you need the investment to deliver on its suggested returns to afford your personal loan, this route is a bad idea. No investment can offer a 100 percent guarantee on returns, but one thing is guaranteed: You’ll need to start repaying your personal loan immediately.
- You have to pay high fees. Before you commit to a personal loan, be sure you know all of the associated costs. Origination fees can be as much as 8 percent of your loan amount, and the lender may charge you for paying your loan off early.
- You’re at or nearing retirement age. As you approach the end of your working years, you should aim to reduce your expenses. Adding debt just as your income decreases could put your retirement savings at risk.
Considerations before borrowing to invest
There are a few additional considerations to keep in mind before using personal loans for investments.
Investing is a smart way to grow your money, but there are a number of ways to go about it. Different approaches have different levels of risk and volatility. Before borrowing money to invest, make sure you’re fully aware of the different types of investments you can fund and their risk levels.
Bank deposit products, like money market accounts and savings accounts, are considered low-risk investments since they’re insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA). These investment vehicles, however, offer lower returns because they’re low risk.
Current loan rates
Financial institutions and lenders often set their interest rates based on the federal funds rate. When the economy is down, the Federal Reserve can lower the federal funds rate. Although lenders can charge what they want on a personal loan, a lower federal funds rate might reflect lower interest rates on consumer lending products overall.
Borrowing to invest is a move that requires a keen understanding of the market, the risks and returns of each investment vehicle and a solid grasp of your risk tolerance. Debt from a personal loan can complicate your investment strategy.
It’s a smart move to consult with an investing advisor to see if using a personal loan is beneficial based on your current financial situation and portfolio.
Your personal risk tolerance
Before you decide to use a personal loan for investing, it’s important to seriously consider your comfort level with potential losses. Think about your risk tolerance and whether a safer or more aggressive investment strategy suits your needs
The bottom line
Using personal loans for investing isn’t for everyone. There’s always a danger that your investment might not yield the return you anticipated. Other events, like an unexpected layoff or a hospital bill, can also derail your monthly finances, making it difficult to repay the loan.
If you’re in a stable financial position, have spoken to an investment professional and feel that borrowing to invest is the right choice, make sure to compare different types of personal loan lenders. Whether you go through a traditional financial institution, online lender or peer-to-peer lender, each lender has different terms, rates and fees that you’ll want to assess.