Should you use personal loans for investing?
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Whether you’re planning for a large purchase or paying for an emergency home repair, a personal loan is a helpful tool. Because funds from personal loans can be used for nearly any purpose, you might even be considering using one for investing.
Taking out a personal loan to use for investments might seem like a foolproof way to build your wealth. Though it is an option, using personal loans for investing also carries serious risks.
Can I use personal loans for investing?
The short answer is yes; it is possible to use a personal loan for investing. When you take out a loan, the money is provided in a lump sum that can be used for nearly anything you would like. But read the fine print carefully, as some lenders may prohibit using the proceeds for specific types of investments, such as purchasing stocks, mutual funds or similar investments.
Even in cases when you are allowed to use the proceeds for investing, that doesn’t mean it is necessarily wise to do so. Investing comes with risks, including the potential that you could lose the money entirely. This type of outcome could put you in a difficult situation if you intended to use investment proceeds to repay the loan.
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, depending on the specific type of investment you’re considering.
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. Because traditional student loans generally don’t cover continuing education, a personal loan may be one of your only options in order to invest in career advancement.
Obtaining a personal loan for this type of investment in your future may 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 to help determine whether making such an investment will pay off.
The downside of using personal loans to invest in continuing education is you’ll generally pay a higher interest rate than you would for a student loan. If you will be attending a continuing education program at least half time, it may be worth investigating Direct Unsubsidized Loans from the federal government, which offer lower interest rates.
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
Using a personal loan to invest in a side hustle or increase your income can be a wise investment if you take the time to develop a sound business plan and ensure you have thought through how you will generate income and pay back the loan.
It may be easier to qualify for a personal loan to invest in a passion project than it would be to qualify for a business loan. Before taking this approach, however, it’s a good idea to review all of your funding options and find the choice that will be the most cost-effective, including finding the option that will charge the least interest and most favorable repayment terms for your financial needs.
You have excellent credit
Your credit score is one of the biggest factors that influence 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.
When you qualify for the most competitive interest rates, you will pay less interest over the life of the loan–meaning borrowing the money will cost you far less and thus is less of a risk.
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 after you’ve crunched the numbers and looked carefully at your budget, you still feel confident about your ability to repay the loan, this might be an option for you.
If you can easily afford the monthly payments, however, you might consider squirreling away the money in a savings account until you can afford to pay for the investment yourself out of pocket- which eliminates any risk associated with taking out a personal loan, as well as interest fees.
Yet another alternative is fractional investing, through which you could use the money you would otherwise have put toward monthly personal loan payments, to buy into investments gradually. This option also allows you to avoid the interest and risks associated with a personal loan.
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 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. In addition, there will be fewer lenders who will likely be willing to give you a loan.
If this is the case, you may want to spend some time improving your credit score before taking out a personal loan. 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–with interest. There are also late payment fees if you fall behind on repayment.
If you’re considering using a personal loan for an investment and require a more reliable investment option, fully investigate the different types of investments. Some, such as money market accounts, offer far reduced risk and volatility.
You have to pay high fees
Before you commit to a personal loan, be sure you know all of the associated costs. Origination fees, which are upfront fees charged to process your loan application, can be as much as 8 percent of your loan amount.
These are not the only fees associated with personal loans. There may also be late fees and fees for paying off the loan early. All of these fees may ultimately eat away at any profit you stand to make from an investment.
Rather than incur such fees to invest money, it may make more sense to create a savings fund where you set aside free cash that can be invested.
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 like a personal loan just as your income decreases could put your retirement savings at risk.
Not only will you be adding to your monthly expenses at a time in life when your income may be decreasing, but you may also face more serious challenges if the investment doesn’t deliver and you default on the loan. Your credit score will be impacted and you may face lawsuits from lenders.
Things to consider 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.