Should You Take Out a Personal Loan to Invest?
Trevor Mahoney is a financial services writer and content creator based out of Los Angeles, California. He holds a Bachelors of Science in Finance from Santa Clara University. In his free time, he enjoys hiking and lounging on the beach.Read full bio
At a Glance
The idea of having access to funds for investing via a personal loan is an enticing prospect. However, there are a very large number of risks associated with this strategy, not to mention the fact that you will be required to pay the money back, including all interest immediately in the form of monthly payments.
Let’s dive a little deeper into this strategy to see why a personal loan for investing may or may not be the right choice for you.
In this article, you’ll learn:
- What is a personal loan?
- Why do investors consider taking a personal loan for investments?
- Can you use personal loans to invest?
- When does using a personal loan for investments make sense?
- When does using a personal loan for investments not make sense?
- Factors to consider before borrowing a personal loan to invest
- Other options for building your investments
What is a personal loan?
For those unfamiliar, a personal loan is a form of borrowing money from a lender. Essentially, after requesting a specific sum of money and being approved for that amount, you are provided with a lump sum up-front. After receiving this lump sum, you are responsible for monthly payments that are a portion of the total sum of the loan. These monthly payments will also include interest and any fees.
Learn more: Know About Personal Loans
Why do investors consider taking a personal loan for investments?
A personal loan for investment is a strategy that inherently has a high risk due to the volatility of the stock market. Some investors choose to use a personal loan for investments to gain access to the funds immediately when they are extremely bullish on a stock pick. In most cases, though, these are seasoned veterans who have years of experience in the stock market.
For the everyday trader, using a personal loan for investments can come with high risks that don’t make the strategy worth it.
Can you use personal loans to invest?
The short answer to can you use a personal loan to invest is yes. While some lenders may require you to disclose the purpose of the funds or may have regulations on what the funds can be used for, many do not. Most personal loan lenders simply provide you with the money and allow you to do with it what you please.
Compare: Best Personal Loans
When does using a personal loan for investments make sense?
In some cases, using a personal loan for investment purposes can make sense. Below are some common examples of when this strategy may apply:
1. You can get a low interest rate
With a good credit score, you may qualify for a favorable interest rate. Assuming this rate is low, and you can afford the monthly payments, this strategy may be worth it. When you receive returns on your investments, a portion of them will likely go towards your repayments. Having a lower interest rate will make the amount of your returns needing to go towards repayment less.
2. Your income may increase
The amount you owe monthly on a personal loan will not change assuming you are locked into a fixed interest rate. Considering this, if you know your income will change for the positive soon, the loan may become more affordable over time.
3. You’re highly confident in the investment
Perhaps you are a seasoned veteran in the stock market yourself and are extremely confident in the short-term returns of a stock pick. If this is the case, using personal loan funds to maximize this benefit could work in your situation. However, always be aware that the stock market is unpredictable and volatile.
4. Career advancement purposes
Investing in your future may not be the same as investing in the stock market, but it is still investing, nonetheless. Using personal loan funds to help pay for the costs associated with classes, a professional license, or other career advancement items can be an excellent idea if it results in an overall increase in your income level.
5. You are financially stable
If you are in a place where you can meet all debt payments on time and in full, even if your investment choice completely tanks, then the risk of using a personal loan for investing is largely mitigated.
When does using a personal loan for investments not make sense?
On the other hand, there are many situations where using a personal loan for investments does not make sense. Watch out for the below and reconsider taking on a personal loan for investing if any of these apply:
1. You aren’t confident in the investment
Above all, if you don’t have experience in the stock market or are not entirely confident in your investment choice, using a personal loan for that investment is not a good idea. Your investment could potentially completely tank in value, leaving you nothing to repay the loan with. Assuming your financials aren’t completely stable, this will leave you unable to meet your payments on time.
2. Interest outweighs your returns
For those with worse credit scores, the interest rate offered on a personal loan may not be favorable in the slightest. If this is the case, the value of your returns may be completely overshadowed by the amount you would owe in interest. In this situation, using a personal loan for investing is not a viable strategy.
3. You can’t afford the payments on the loan
Put simply, you should never take on any debt you aren’t able to pay back in full and on time. Ideally, any debt you do take on should be manageable even if there is a slight change in your income levels or personal situation.
4. Your history with credit is not ideal
Getting a loan to invest when you have a poor history of credit is dangerous since it is likely an indicator that you are not able to handle debt. Rather than taking on this type of debt, take the time to focus on improving your credit score before applying for a loan.
5. Retirement is near
With retirement on the horizon, you will want to leave your nest egg as intact as possible. Having to completely deplete your life savings in order to pay back a personal loan when your investment tanked would be a challenging situation. Don’t risk your retirement funds for a short-term investment opportunity.
Factors to consider before borrowing a personal loan to invest
After reviewing the above, you may have concluded that taking out a loan to invest may be in your best interest. If this is the case, consider the following factors to make the final determination of whether this strategy is right for you:
1. How experienced you are in investing
As a novice investor, it’s possible that an investment decision you believe in will take off with excellent returns. However, it is not likely. The stock market and investment field in general are extremely unpredictable and volatile. Taking out a personal loan for investments is only best for those with vast investing experience, and even then, it is not without major risks.
2. Interest rates on loans
If interest rates on loans are at historic highs, it’s likely not the best time to use this strategy. Returns on investments will likely be small, and a high interest rate will mean that all your returns and then some are going towards meeting your monthly payments. Consider waiting for interest rates to drop.
3. Your current financial portfolio
Is your current financial portfolio in ruin? Is your current financial portfolio already packed with investments? In either of these cases, taking on a personal loan for investments likely isn’t a worthwhile choice.
4. What you are willing to lose
Whenever you make an investment decision, a good rule of thumb is to ask yourself whether you are willing to lose every dime you are investing. On top of that, ask yourself if you can afford to lose every dime you are investing. If the answer to both those questions is yes, then perhaps taking out a personal loan for investing will not carry as much risk with you as it would for others.
Other options for building your investments
There are alternative methods to build your investments that typically carry less risk than taking out a personal loan.
1. Pay off your debt and invest your savings
Debt will always drag your total investable savings down. Consider taking the time to pay off all your debt before focusing on investments. Once your debt has been covered, you can use any remaining savings from your income for your investment decisions. Be aware, though, that any investment decision should be considered carefully and with the help of professional guidance.
2. Focus on your 401(k) or IRA contributions
At the end of the day, retirement savings are what allow a person to stop working. As a result, they should be considered your highest priority with investing. Max out your 401(K) contributions every year along with your IRA contributions to ensure you are making the most out of these accounts.
3. Mutual fund investing
Mutual funds are professionally managed investment funds that pool money from many investors in order to purchase the securities in the fund. Considering they are professionally managed; the risk is typically less than if a novice investor were going to try to make a stock picking decision by themselves.
Using a personal loan to invest can make sense in some circumstances, but there is a serious amount of risk associated with the strategy. When taking out a personal loan to invest, consider what would happen if your investment dropped to absolutely nothing. Would you be able to afford a repayment cost when investing in a personal loan? If the answer is no, borrowing money to invest likely isn’t the wisest strategy.
Yes, most lenders will not have requirements for what purpose the personal loan they lend to you is used for. However, just because the answer to can you invest a personal loan is yes doesn’t mean it’s something you should do. Evaluate the pros and cons before making this decision.
The answer to can you take out a personal loan to invest is yes. However, there are serious risks associated with this strategy, such as your investment choice completely losing value. If this were to happen, you would be responsible for meeting all payments out-of-pocket, rather than being able to use some of your returns.