Should You Use a Personal Loan for Investing?
Yes, you can use a personal loan for investing, but it’s a gamble. Your investment might not earn more than the interest you’d pay on a personal loan.
That doesn’t mean that personal loans for investing are always a bad idea. It’s just important to understand the risks — and know you may have better options.
- Many lenders, but not all, let you use a personal loan for investing.
- The average stock market return is about 10%. If your personal loan rate is higher than your return, you will lose money by investing.
- Even if your investment was performing well at the start of your loan, you could end up in a bad financial position if the market declines.
- Personal loans could be a good idea for certain investments, like investment property renovations.
- There are loans that are specific to investing that might be less risky and cheaper.
Can you use a personal loan for investing?
A personal loan comes as a lump sum of money that you can use for almost anything. Investments are a different story.
Some lenders (like First Tech) allow you to use a personal loan for investing and buying crypto. But many forbid it, such as LightStream, SoFi and Upgrade. These restrictions should make you pause.
Investment returns are never guaranteed, whether you use your own cash or a personal loan. If your investment doesn’t work out, a personal loan could leave you empty handed. Not only that, but you paid interest on it, too.
How does investing with a personal loan work?
Even if your investment does perform as expected, your gains will be offset by the interest you paid on your loan. Consider the example below:
- Personal loan amount: $10,000
- Personal loan term: 5 years
- Annual percentage rate (APR): 10%
- Monthly payment: $212.47
- Total amount repaid, including interest: $12,748.23
Imagine you invested the loan above into an asset with a 6% projected annual return.
After five years, the $10,000 you invested grew to $13,382.26. However, you paid $12,748.23 for your loan. That leaves you with a small gain of $634.03, which took five years to accumulate.
There’s also a problem with this scenario — market volatility. If your investment doesn’t perform as well as expected, your gain will shrink and you might even lose money. This scenario also ignores capital gain taxes you’ll pay on your gains.
Use a personal loan calculator to see how much overall interest you will pay on your loan. This will help you decide whether investing using a personal loan is worth it.
Pros and cons of taking out a personal loan for investing
Pros
- Fast funding, letting you take advantage of market changes
- Interest rates are fixed, so your monthly payment will stay the same
- Don’t usually need collateral
Cons
- High interest rates may eat away at your gains
- Your personal loan payments will still be due, regardless of how your investment performs
- The stock market is volatile and a downturn could mean debt with no profits
When using a personal loan to invest could make sense
You have excellent credit and qualify for low rates
Some personal loans for excellent credit have low APRs, sometimes lower than the average stock market return of 10%.
Don’t expect the lowest rates unless you have a 740+ credit score, higher income, manageable debt and a spotless payment history. Even then, you might not qualify for the cheapest loan. Every lender has its own way of calculating interest rates.
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You are a seasoned investor
You should have a firm grasp on how your investment portfolio works before using personal loans for investing. You stand to lose a lot of money, depending on your rate and how much you invest.
And remember, the market is unpredictable regardless of how much experience you have.
Your investment has a fixed return
The most reliable investments have a fixed rate of return, such as I bonds and certificates of deposit (CDs). If the annual percentage yield (APY) on your fixed investment is higher than the APR on the personal loan, you could make money by using a loan to invest.
At the time of this writing, you probably won’t find a CD with an APY that will offset the interest rate on your personal loan. The best CDs are currently hovering around 4.50%. I bonds are even lower, at a composite rate of 3.11%.
You own an investment property that needs renovations
If you already own a fixer-upper investment, consider a home improvement loan to pay for repairs and renovations. The money comes as a lump sum, and you can use it to pay for materials, contractors and just about anything else.
An alternative could be a home equity line of credit (HELOC), but HELOCs are typically harder to get on investment and second homes.
You want to invest in yourself by getting a certification
Getting a certification or going to trade school could be an investment if it leads to a higher paycheck. Federal student loans are often the best option, but not all career programs qualify. On top of that, you must be enrolled at least half-time to qualify for a federal student loan.
If you don’t qualify for a federal student loan, a personal loan for students could be something to consider. Most lenders won’t let you use a personal loan to pay for college, but certifications and vocational training are usually fair game.
Risks of taking out a personal loan to invest
Your investment might crash
You could lose your money if your investment crashes, and you’ll still need to repay the loan. When borrowing money to invest, you stand to lose more than what you put into your investment. That’s because you have to pay back the interest on the loan.
You might owe more interest and fees than you’ll earn on the investment
Even a hot investment might not earn enough to make up for the interest rate, fees and taxes you’ll owe on your loan. Personal loan interest rates generally range from 6% to 36%. Some lenders also charge an origination fee.
Personal loans typically aren’t taxable, but investment gains usually are. This will also reduce your profit.
Missing loan payments hurt your credit
When borrowing to invest, you’re not only gambling that the loan will make money. You’re also betting that you can make your loan payments, regardless of how your investment performs.
Your payment history makes up 35% of your FICO Score. One missed payment could cause your credit score to fall, sometimes as much as 100 points.
You’ll have more debt
A personal loan will tip the scales of your debt-to-income (DTI) ratio. Your DTI measures how much debt you have compared to your income. It’s best to have a DTI of 35% or less. Higher than that, you risk a drop to your credit.
You may have other, cheaper financing options
One of the perks of personal loans is their flexibility. A mortgage requires that you buy a home, and auto loans are only good for vehicles. You can use a personal loan for almost anything.
Be that as it may, it might be less risky and overall to go with a loan that’s meant for your specific investment.
Alternatives to using a personal loan for investing
Margin loans
If you want to invest (more) in the stock market, consider a share margin loan.
You already need some investments to get a margin loan. But if you do, it may be a better choice than a personal loan. This is a loan that you get from your brokerage, and it uses your current investments as collateral.
Margin loan rates vary based on factors like the brokerage itself and the size of the loan. Generally, though, they’re lower than most personal loans. The amount you can borrow is typically limited to a percentage of the eligible securities in your account.
Borrowing on margin isn’t without its risk, either. If the value of your margin account dips too low, you might end up with an out-of-pocket loss, plus whatever you owe on your loan.
Investment property loans
If you want to invest in property, consider an investment property loan.
An investment property loan is specific to real estate and it can help you buy a flipper house or rental properties.
Investment loans are a type of mortgage, so they use the property you’re financing as collateral. There are a few different types of investment property loans; some require you to live on the property and some don’t.
These loans can be hard to qualify for. For instance, you must have enough cash in the bank to cover a certain number of mortgage payments. Some lenders also require that you have experience in property management.
Even with these drawbacks, an investment property loan could be worth it because their rates are typically lower than personal loans.
Crowdfunding
If you want to invest in your side hustle, consider crowdfunding.
Crowdfunding can help you elevate your side hustle into a true small business. Here, you’ll use a platform to raise money from supporters or investors. In exchange, you’ll give them equity in your company, free rewards or profit sharing.
A successful crowdfunding campaign requires marketing. The crowdfunding platform may also charge fees and/or keep a percentage of the money you raise. These fees could still end up cheaper than the interest and fees on a personal loan. Plus, all-or-nothing platforms (like Kickstarter) won’t charge you anything if you don’t reach your crowdfunding goals.
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