Have you ever considered taking out a personal loan to invest? If so, you aren’t alone.
When you hear about the ability to make money in the stock market, it can be tempting to find a way to start investing today. This is true even if you don’t have any available cash.
Want to invest, but don’t have cash? Find a personal loan with Fiona
If you’re trying to get ahead, it may seem tempting to take shortcuts to get there faster. Unfortunately, some alternatives are a very bad idea. This includes taking out a personal loan to invest in the stock market in the vast majority of cases.
There may be a very rare time when it makes sense to take out a personal loan to invest. However, I don’t think I would ever do it. Here’s what you need to know.
What’s Ahead:
How personal loans work
Personal loans have a couple of key characteristics that are important to understand.
Personal loans are unsecured debt
First, they are unsecured loans. This means the lender can’t foreclose on your home or repossess your car if you don’t make payments.
Unsecured loans, such as personal loans, have higher interest rates than secured loans. This makes sense because there is nothing the lender can directly seize if you default on your loan. It is riskier for the lender.
Personal loans have a fixed term
Next, personal loans are fixed-term loans. This means you have a set number of months or years to repay the loan after you take it out.
Based on your balance, interest rate, and term, you’ll have to make a payment each month that results in paying off the loan at the end of the term.
This is unlike a credit card where you can carry a balance from month to month and make minimum payments.
This is important if you’re considering investing the money. It means you have to make a fairly decent monthly payment each month. You can’t pay the minimum and pay the rest off at the end of the loan.
Can I use a personal loan to invest?
Unless your lender specifies otherwise, a personal loan can be used for anything you want. This includes investing in the stock market.
That said, some lenders will offer you lower personal loan interest rates if you use the money for certain purposes. That’s because some uses may result in a lower risk to the lender than others.
For instance, personal loans for debt consolidation may require the funds to be disbursed directly to the loans you’re consolidating. Read the terms of your loan to understand if there are any restrictions on the money.
Why would someone take out a loan to invest?
A person may be tempted to take out a personal loan to invest if they see an opportunity to make money. If a person could earn higher returns investing the money they borrow than they pay in interest, they could come out ahead.
This can be very tempting after a stock market crashes and then starts rebounding. In some cases, you may see sharp gains for a few days or weeks that would exceed the costs of some personal loans over a year.
When would this be worth it?
Taking out a personal loan to invest only makes sense when you’re very confident your investment gains will exceed the costs of the loan.
For instance, let’s say you can take out a personal loan with an 11.99% interest rate. It would only make sense to use this money to invest if your returns could exceed that 11.99% cost.
Investing is volatile, though. Nothing is guaranteed. It probably wouldn’t make sense to take out an 11.99% personal loan to earn 12% by investing. Due to taxes and the minimal amount you’d gain, you wouldn’t come out ahead.
In order for the risk to be worth it, you’d likely have to get returns that greatly exceed the interest rate you pay on your personal loan.
There are other types of investments other than the stock market. Some of these investments may make more sense to use a personal loan for.
For instance, let’s say you have the opportunity to invest in your small company that has a huge profit margin. Unfortunately, you can’t get access to cash any other way than a personal loan for whatever reason.
If you put in $10,000 but could earn $20,000 from that investment in three years, it may make sense to take out a personal loan to invest.
Why it may be a good idea to take out a personal loan to invest in the stock market
Taking out a personal loan to invest in anything, including the stock market, only makes sense in one scenario. This scenario is when you know with a relative degree of certainty that your returns will exceed your costs.
Investing in the stock market at any rate of return is far from certain. I personally do not believe it is ever a good idea to take out a personal loan to invest in the stock market.
Why it may not be a good idea to take out a personal loan to invest in the stock market
There are several reasons why taking out a personal loan to invest in the stock market is a bad idea.
Personal loans have fixed terms
First, personal loans have fixed terms that are usually relatively short. Personal loan terms typically don’t exceed seven years, although they can be longer in some cases.
Short terms are a problem because most investments vary in returns greatly from year to year. The returns average out over the long run, but the short-term returns are very unpredictable.
While seven years seems like a long time, it isn’t in the grand scheme of the stock market.
High interest rates
Personal loans don’t offer low interest rates like car loans and mortgages do. While you may see low personal loan rates advertised, such as 5.99% APR, people rarely qualify for them.
These low rates are usually for funds for a specific use, such as debt consolidation. Additionally, they’re typically for the shortest term loan, such as 24 months. Finally, you normally have to have impeccable credit to qualify for these rates.
To make matters worse, the longer the loan term is, the higher your interest rate will be, too. In order for you to invest for a long enough period to have investment returns be less volatile, it would cost you even more in interest payments. This could cut down on your potential profit.
You have to make monthly payments on your loan
Personal loans require you to make equal monthly payments. When you’re invested, you don’t want to have to sell portions of your investment to make payments.
Doing so would lower your return. It could also cause you to sell when your investment is performing poorly, resulting in locking in a loss.
Other types of investments that have greater returns may not be as liquid. This means you can only sell them at certain times. If you can’t get your money out to make your monthly payment, you could default on your loan.
Who should consider taking out a personal loan to invest?
In my opinion, only people with investments that have guaranteed returns and very little to no risk should take out a personal loan to invest. These investments rarely exist.
The risk isn’t worth the relatively low amount you’ll earn over the interest costs of the loan in the vast majority of cases.
This means most people should avoid taking out a personal loan to invest.
It’s about risk and return – here’s an example
Let’s say you take out a five-year personal loan for $10,000 to invest in the stock market. There is no origination fee, so you get the full $10,000 upfront. Interest rates from these loans vary, but you get an 11.99% APR for the purposes of this example.
Your investment has a break out period and you get an incredible 15% return on your investment each year. In this case, it might make sense to take out a personal loan to invest. Unfortunately, you’d only know this after the fact.
At the same time, your interest is not tax-deductible. You would have to pay income taxes on the gains on your investments. This would reduce your profits.
Even without taxes, you’d only theoretically earn a 3.01% difference between the loan APR and the return from the investment.
Once you consider the fact that you’d have to make a monthly payment of about $222, things get trickier. You’d have to have cash on hand to make this monthly payment or you’d have to sell some of your investment each month to make your payments.
If your investment varies in price, you may end up having to sell low to make your monthly payment. This could reduce your future returns below the 15% per year the investment would have returned if you left the money in the investment the entire time.
Let’s now look at an example with a more reasonable rate of return for the stock market. Let’s assume you earn an 8% return each year.
In this case, you’d be paying 3.99% per year to invest. This makes no sense. You wouldn’t take out a personal loan to invest because it’d cost you money to do so.
Personal loan providers you may want to consider
If you happen to have an investment opportunity that would likely result in a higher return than the cost of the loan, here are a few lenders you may want to consider.
Fiona
Fiona doesn’t directly offer personal loans, but they do help you find a personal loan lender. Once you pick the type of loan you want, you input a few details about your situation. In the case of personal loans, you input your credit score range, zip code, loan purpose, and the amount of the loan you’re requesting.
Based on this information, Fiona will display several lenders that may match your needs. They show you estimated terms, APRs, and monthly payments. If you find an offer you like, click continue. You’ll be directed to input information to get personalized loan offers for your situation.
Find a personal loan lender with Fiona.
Monevo
Monevo is another personal loan aggregator website. You’ll just some basic information about yourself and the purpose of your loan to get quotes from more than 30 different lenders. The process won’t affect your credit score, and you’re under no obligation to accept any of the offers.
If you want to get a feel for the lenders and rates being offered, you can browse a list before you even start the quote process. Loans are available in amounts up to $100,000, with rates range between 1.99% – 35.99% APR. If you like one of the offers, you’ll then progress to the full application.
By shopping multiple lenders at once, you’ll save time and increase your chances of getting great rates. Whether you go with one of the quotes offered or not, you’ll get a great idea of the rates and terms you can expect.
Get personal loan rate quotes from Monevo.
Credible
Credible is another personal loan aggregator. They allow you to check your personal loan rates without impacting your credit. Since it doesn’t hurt your credit, it doesn’t hurt to check to see if they have any offers the other aggregator sites don’t that may offer you a better rate.
Credible is so confident in their ability to offer the best rates that they’ll give you $200 if you find a lower rate. Of course, terms apply so look at the details of the offer. See Terms*. Even with this guarantee, it still makes sense to shop around to ensure you’re getting the best rate.
Get personal loan quotes from Credible.
Credible Credit Disclosure – Requesting prequalified rates on Credible is free and doesn’t affect your credit score. However, applying for or closing a loan will involve a hard credit pull that impacts your credit score and closing a loan will result in costs to you.
Places to consider investing if you decide the potential returns are worth the risk
If you decide to take out a personal loan to invest, here are a few of the options you may consider.
Robo-advisors
Robo-advisors manage your money on your behalf by using technology instead of human financial advisors. Based on your risk tolerance, robo-advisors generally set up a well-diversified portfolio.
Robo-advisors usually charge a fee for their service, which will cut into your returns. Since robo-advisors typically take a diversified approach, you aren’t likely to hit a home run and get amazing returns.
Self-directed brokerage accounts
Self-directed brokerage accounts allow you to pick what you want to invest in. You could invest in several options including individual stocks, mutual funds and ETFs.
Self-directed brokerage accounts allow you to have a better chance of getting returns that exceed a personal loan’s interest rate. At the same time, they can also result in a larger loss.
ETFs
Exchange-traded funds (ETFs) are a basket of investments that help you diversify. When you buy an ETF, you’re normally purchasing several investments. Some ETFs are as large as the S&P 500 index while other ETFs only follow a small sector or industry.
If you want to bet on a particular industry with an ETF, there is a chance your returns could be high enough in the short term. If you bet wrong, your losses could also be massive.
Mutual funds
Mutual funds also allow you to invest in a basket of investments. Rather than trading live throughout the day, mutual funds settle all trades and reprice once per day after the markets close.
Like ETFs, you can use mutual funds to purchase a very diversified basket of investments or a small portion of investments such as a certain industry.
Real estate crowdfunding
Real estate crowdfunding is a much talked about investment option. Here are two companies that may offer investments you could be interested in.
Roofstock
Roofstock currently offers two main services. The first allows you to buy rental properties from around the country. Personal loans normally won’t provide enough cash to invest in most of these properties, so it isn’t really an option to invest personal loan proceeds.
What may be an option is Roofstock’s Roofstock One offering. This allows you to buy shares of a rental property rather than the whole thing. Only accredited investors can invest in Roofstock One, though. Most people taking out a personal loan to invest don’t likely fall into this category.
Learn more about Roofstock.
Fundrise
Fundrise is a real estate crowdfunding option that doesn’t require you to be an accredited investor. Rather than let you invest in individual properties, you invest in a portfolio of properties Fundrise sets up. They have a starter portfolio as well as three other portfolios you can choose from depending on your goals.
Unfortunately, Fundrise displays its historical annual returns (8.7% to 12.4%) on the front page of its website. These returns aren’t high enough to allow significant profit after taking out a personal loan, so it isn’t a good idea in most cases.
Learn more about Fundrise.
This is a testimonial in partnership with Fundrise. We earn a commission from partner links on MoneyUnder30. All opinions are our own.
Summary
Ultimately, it almost never makes sense to take out a personal loan to invest in the stock market. In rare cases, it may turn out to be profitable if you get lucky.
Even so, the profit probably won’t be very large compared to the risk you’re taking.
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Source: moneyunder30.com