Most of us are familiar with borrowing to invest in property; however, investing in shares is a relatively new concept.
The low-interest rate and rising stock market make it an excellent time to invest in stocks and maximize profits quickly.
But is it that simple? Let us figure it out in this blog. Read on to learn the pros and cons of borrowing money to invest in stocks or shares, how to do it, and whether it is worth considering.
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1. Why Would I Borrow To Invest?
Borrowing money to invest is called gearing or leverage, which allows you to invest more than you have already saved. It is beneficial if the value of your borrowed cash rises more than the interest you pay on that money.
Here are two main reasons why people would consider borrowing to invest:
You can benefit from the rise in the investment value without making an upfront payment, i.e., in the case of buying a house.
To access tax benefits for interest payments on the borrowed sum when the interest exceeds any income earned.
2. What Is A Margin Loan?
A margin loan is like a mortgage that enables you to borrow money to invest in shares, exchange-traded funds, and managed funds.
Margin lenders who offer this loan require you to maintain the loan-to-value ratio less than a pre-decided level, i.e., mostly 70%.
3. What Are The Downsides Of Borrowing To Invest In Shares?
Many people ask if it is illegal to borrow money to invest. No. It is not, but it involves various types of risks:
The most significant disadvantage of borrowing to invest is that even if the return on investment is negative, you still have to pay the loan balance and interest repayments. It may amplify any losses to the extent that you may even owe more than you own.
Another drawback of this strategy is that leverage can give you massive gains but can also lead to significant losses over the short run. Therefore, it is wise to borrow only the amount you are comfortable investing for the long term. Otherwise, it may cause your savings to wipe out entirely.
Furthermore, the income you generate from investment could be lower than expected. For example, if you took a loan to buy shares in a private company and it didn't pay a dividend. Ensure you can cover living expenses and loan repayments without earning investment income.
If the return (after tax) is greater than the investment and loan costs, you are taking a higher risk for a negative or low return.
4. What Are The Benefits Of Borrowing To Purchase Stocks?
Are you thinking, how can I make money by borrowing money? Here are some good reasons why taking on some debt can help enhance your stock portfolio and investment returns.
Build a more extensive portfolio at a faster rate than when you use your funds
Use leverage to maximize profits and earn higher returns.
Access additional stocks to diversify your portfolio without selling any shares.
Some lenders lend you money based on your current share portfolio as collateral. So, you can increase your investment size without depositing extra funds.
You can borrow and invest in stocks of other sectors using the equity in your existing portfolio. This way, you can manage concentration risk in your portfolio.
Benefit from potential tax deductions linked to borrowing. You can avail of tax benefits through negative gearing if the income you earn from your stocks is below interest costs.
5. Can I Borrow Money And Put It In Stocks?
Yes. If the idea of borrowing money to invest in stocks interests you, then here are two ways to do it:
Use Margin Loan
Approach a lender to get a "margin loan ." Here the lender will grant you a loan against your stock portfolio.
The problem with this method is that if the stock price falls, the bank may call you to put in extra money to bring the loan-to-valuation ratio to the desired level. On failing to do so, the lender may sell your stocks.
Use The Accumulated Equity In Your Home
Want to know how do the rich borrow against their wealth? You can consider using some of the equity in your home to buy stocks.
Compared to the earlier method, you pay a lower interest rate which keeps your repayments down. You can direct more funds to additional investments or repay your outstanding non-deductible home loan.
Another benefit is that you have much more control, with a negligible chance of a margin call. Also, you can get started without an existing stock portfolio.
However, the Australian Securities & Investments Commission Moneysmart platform warns first-home buyers and occupiers against this option. If the investment turns terrible and you can't keep up with debt repayments, you may also lose your home.
6. How Can I Qualify For A Loan To Invest In Stocks?
Investment loans involve a higher risk than standard home loans. It implies that you must be financially stable to qualify for the loan.
Here are the essential lending criteria that almost all lenders follow:
You should have stable employment.
You should have between 5% and 10% in genuine savings.
If borrowing is over 90%, lenders will require equity in other properties as collateral.
You must have a good credit history and above average credit score.
7. How To Find An Investment Loan For Borrowing Against Shares?
An investment loan is a higher risk to the bank. Both bank and non-bank lenders offer up to 95% of investment loans in Australia. However, the qualifying criteria for the loan can vary between lenders.
Interest-only loans are popular among investors as it requires paying only the interest component of the loan. It means that your mortgage repayments are low. However, there are a few downsides:
The principal doesn't go down, so you always accrue interest on the original loan amount. Otherwise, you can consider principal and interest repayments that reduce the loan amount with time.
These loans only last for a while. After a specified period, you must also begin paying the principal.
Here are popular investment loan options that help you build wealth by investing in managed funds and listed shares:
Westpac Online Investment Loan
Lends you to invest in an array of approved securities that includes ASX 200 shares, Managed Funds, and ETFs
No application, transaction, or establishment charges
Get preferentially fixed and variable interest rates.
With this loan and a blend of savings and negative gearing, you can create a portfolio of the stocks of the top 20 Australian companies.
Like the above loan, you enjoy 24/7 portfolio access, no application, transaction fees, establishment, and flexible repayments.
Westpac Protected Equity Loan
As the name suggests, the loan lets you invest in an array of ASX-listed securities, including ETFs.
You can use the loan amount to build your portfolio with complete capital protection at maturity and no margin calls.
Also, you are entitled to receive ordinary distributions during the loan term.
8. What To Consider Before Borrowing To Invest?
Here we have discussed a few things you should consider when borrowing money for investment:
Don't select a stock based on its past performance. It may deliver other returns in the future. In other words, the best-performing investment for a year could perform poorly in the next year. That's the reason investing with a long-term perspective is essential.
It is always a good practice to have a plan B to cover the interest expenses on the loan in case of job loss.
When borrowing for stock investment, you may get a 'margin call' if your investment's value declines. In that scenario, you need to infuse more capital to keep the overall gearing within a certain level.
Though negative gearing can offer you tax benefits, investing in negatively geared investments isn't wise. You may benefit from the rising investment value, but increasing interest rates could reduce your overall gains.
Stock investment is a risky business. You must control your emotions while seeing your equity shrinking before your eyes during market downturns. Only borrow if you can stick with your investment plan and stay invested even if the market falls.
Interest Rate Considerations
Remember that investment loan rates will not remain low forever. Investing with the loaned amount may make you less comfortable with each rate increase. That's when it is vital to have an investment strategy to avoid making higher repayments.
9. Is It Okay To Borrow Money For Investment?
While a stock investment loan can hasten the growth of your investment portfolio, it can even amplify losses if the stock price moves against you. This way, you can lose more than your invested capital.
10. Can I Borrow Money To Buy Shares In Australia?
Borrowing for investment to gain short-term returns is terrible, as stock markets are very unpredictable. It increases the amount you will lose if your assets fall in value. You will need to repay the loan and interest even if you incur negative returns.
Other risks include:
If the interest rate rises, you may not cover the loan payments. It can, in turn, force you to sell the investment.
In case of job loss, you may be unable to repay the loan's interest.
Interest costs linked with the loan may lessen your profits. As Interest rates keep changing, it can increase the cost of servicing the loan.
11. What Is The Easiest Way Of Borrowing Money?
Below are the cheapest and simplest ways to borrow money in Australia:
A personal loan from a bank, credit union, or other financial institution
0% APR credit card
Buy now, pay later
A personal line of credit
12. Can I Borrow Money Without A Job?
If you are wondering, "Can I borrow money with no income?" the answer is Yes. You can find a few lenders willing to lend to you without fulfilling the standard lending requirements.
If you are unemployed and don't have any income source, you can take advantage of an emergency cash loan using the below options:
No Interest Loan Scheme
It is another type of loan that borrowers access without job verifications. NILS providers are not-for-profit organizations that approve loan loans to pay for necessary goods or services without charging interest or fees.
However, borrowers must have a healthcare card or Centrelink pension to avail of the loan under this scheme.
No Documentation Or Payday Loans
Though you don't need to provide income proof and pass the credit checks, you have to pay higher interest rates and fees. Generally, lenders do it to safeguard themselves against high risks.
Providing proof of Centrelink payments in place of employment payslips speeds up the loan sanctioning process.
Find A Loan Guarantor Or Co-Borrower
People without an income source can secure a loan if they apply for it with their co-borrower/guarantor, who has a good credit rating.
However, if the borrower fails to repay the debt, the lender has the right to legally go after the guarantor's assets to recover the loaned amount.
Instead of asking for employment/income proof and performing credit checks, the lender lends you money against a moveable or immovable asset you own.
Due to the sizable underlying security, this loan has a slightly more acceptable set of interest rates and fees (still more than usual personal loans).
13. Does It Make Sense To Borrow Money To Invest?
Borrowing to increase your investments can be helpful in long-term wealth-building. It doesn't fit well if you want to achieve financial independence quickly.
Before borrowing to invest, you should ask these questions:
How much risk can you bear?
How safe is the investment platform?
Do you have a diversified portfolio?
In how much time are you likely to see an investment return?
Though borrowing to invest can help accelerate your wealth creation, it also implies taking on more risk where your losses can exceed your invested capital. Whether you repay the debt depends on your investments and timeframe.
Before taking out a stock investment loan, you must consider the loan servicing costs. Seeking professional financial and tax advice concerning the risks and advantages of geared investing is beneficial.
Borrowing to invest is a high-risk business that can lead to more significant returns when markets go up and hefty losses when markets fall.
If you are an experienced investor willing to take that extra risk to reach your financial goals, then the strategy may be an option to consider.
If you are still deciding, you must seek the advice of a financial adviser before investing.
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