Personal loans can be used to fund home repairs, consolidate high-interest credit card debt or cover an emergency expense. There’s also another way to use personal loans: investing in the stock market.
Using loans for investments could help with building a portfolio when you don’t have other cash to invest. While you may generate a solid return on those investments over time, there’s always the risk that you could lose money instead.
If you’re considering using personal loans to invest, it’s important to consider the pros and cons.
Can You Use Personal Loans to Invest?
Personal loans allow you to borrow a lump sum of money that you can use for virtually any purpose. Some of the most common uses for personal loans include home improvements, debt consolidation, vehicle purchases, medical bills, and emergency expenses.
In terms of using loans for investing, you can generally do so unless the lender specifies otherwise. While personal loans typically allow for flexibility in how the money can be used, lenders have the option to impose restrictions.
So why would private investors use personal loans to invest anyway?
There are different reasons for doing so. For some private investors personal loans could make sense if:
• They don’t have other cash available to invest.
• Shifts in the market create a buying opportunity that they’d like to capitalize on.
• Personal loan interest rates are low compared to the return potential for investments.
• They can afford to make the payments on a personal loan.
An investor line of credit is also an option. Unlike a loan, which offers a lump sum of cash to invest, an investor line of credit can be drawn against as needed.
For example, this type of personal borrowing arrangement may suit someone who’s investing in rental properties or fix-and-flip real estate and is unsure exactly how much they’ll need to invest.
When Using a Personal Loan to Invest Might Make Sense
Ultimately, whether you should consider using personal loans for investing may hinge on your investment goals, timeline for investing, and risk tolerance. But there are some situations where it might benefit you.
1. You Can Qualify for the Lowest Rates, Based on Credit
One of the most important factors lenders consider when approving personal loan applications is credit. Specifically, that means your credit scores and credit reports come under scrutiny.
The higher your credit score, the lower your interest rate on a loan is likely to be. If you’re interested in using personal loans for investments then getting the best rate matters.
Why? While you might be earning returns on your investments, you’re paying some of them back to the lender in the form of loan interest. So it makes sense to angle for the lowest rates possible. If you have good to excellent credit, that could be an incentive to get a personal loan or investor line of credit.
2. You May Be Able to Pay the Loan Off Early
Personal loans can be used to fund different types of investments, from stocks to mutual funds to real estate. But again, the interest you pay on the loan can eat away at your returns.
Being able to pay the loan off ahead of schedule could help you save money on interest charges. So think about your budget and what you might realistically be able to afford to pay each month to get the loan paid off early.
But be aware that doing so could trigger a prepayment penalty. While SoFi personal loans don’t have any prepayment penalties, other personal loan lenders may charge them.
If you get stuck paying a prepayment penalty that could wipe out any interest savings associated with paying the loan off early.
3. You’re Confident About Your Return Potential
Some financial experts might say that personal loans for private investors only make sense when they’re guaranteed to get a return that outpaces what they’ll pay in interest. But trying to predict a stock or exchange-traded fund’s future performance is an inexact science and not a recommended practice.
For that reason, it’s important to consider how confident you are about an investment paying off. This is where you may need to do some research to understand what an investment’s risk/reward profile looks like, how well it’s performed in the past, what’s happening with the market currently, and where it might be headed next.
In other words, you’ll want to perform some due diligence before using loans for investments. Looking at both the upsides and the potential investing risks can help with deciding if you should move forward with your personal loan plans.
When You Might Think Twice About Using Personal Loans for Investing
While there may be some upsides to using personal loans for investments, there are some potential drawbacks to weigh as well.
1. You Don’t Qualify for the Best Rates
When using personal loans for investing, the math becomes important since any interest you pay has to be justified by the returns you earn. Even if you’re investing in something that you’re sure is going to result in a sizable gain, you still have to consider whether the interest fits in.
If you don’t have great credit then any returns you realize may be overshadowed by the interest you’re paying to the lender. The total interest cost increases the longer you pay on the loan, which is also something to keep in mind if you’re considering a two-year, three-year, or even five-year repayment term.
Before applying for a personal loan, it’s helpful to check your credit reports and scores to see where you stand.
This can help you gauge what type of interest rates you’re most likely to qualify for if you do decide to go ahead with a loan.
2. You Have a Lower Risk Tolerance
Investments aren’t risk-free and some are riskier than others. If you’re taking on debt to invest in the market, you have to be reasonably sure that your investment will pay off. In the meantime, you have to be comfortable with the risk that involves.
The stock market moves in cycles, and volatility can affect stock prices from day to day. So it’s good to understand how you typically react to volatility and what level of risk is acceptable to you before taking out a personal loan.
If the idea of being stuck with a loan for an investment that doesn’t pan out isn’t something you can stomach, then it may not be right for you.
Likewise, you may want to take a pass on a personal loan if you’d be investing in something that you don’t fully understand or haven’t thoroughly researched.
3. Your Income or Expenses Could Change
Taking out a personal loan means you’re committing to repaying that money. While you might be able to afford the payments now, that may not be true if your income or expenses change down the line.
Something investors might not like to think about, but is a risk, is what if the market doesn’t perform favorably? What happens if there is a loss on the investment and you have to find other funds to make the personal loan payments? It’s a good idea to have a backup plan because even if the investment doesn’t provide the return that’s expected, the lender will still expect payments on that personal loan.
Before applying for a personal loan, ask yourself whether you’d still be able to keep up with the payments if your income were to decrease, your other expenses were to go up, or the investment didn’t see the return you thought it would.
If you don’t have an emergency fund in place, for instance, how would you manage the loan payments? Would you have to sell the investments you made to make a loan payment? Could you borrow money from friends or family?
Thinking about these kinds of contingencies can help you decide if a personal loan for investing is the best way to go.
What to Consider With Personal Loans for Investing
Before taking out a personal loan for investing, there are a few things to keep in mind. For instance, consider things like:
• How much you can afford to pay toward personal loans monthly.
• How much you need or want to borrow.
• Current personal loan interest rates.
• Which rates you’re most likely to qualify for, based on your credit history.
• Any fees a lender may charge, such as origination fees or application fees.
• Whether you’ll be able to repay the loan early and if so, what prepayment penalty might be involved.
Beyond credit scores, also consider what else is needed to get approved for a personal loan or an investor line of credit. For instance, lenders may look at your debt-to-income ratio, employment history, and what you plan to use the loan proceeds for.
Also, think about where you plan to use the money to invest. If you’re interested in trading stocks or ETFs, for example, you may want to choose an online brokerage that charges $0 commission fees for those trades.
The fewer fees you pay to your brokerage, the more of your investment returns you get to keep.
Using personal loans for investments may suit some investors better than others. It’s important to weigh the potential rewards against any risk you may be taking on before committing to a personal loan for investing.
If you’re planning to use personal loans to build a portfolio, take time to compare lenders online to find the best fit for your needs, credit history, and budget. SoFi unsecured personal loans, for instance, offer competitive interest rates and come with no fees.
Photo credit: iStock/jacoblund
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