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Making the money required to invest can take time, so you may be wondering if using a personal loan for investing can be a good shortcut.
But while it can be tempting, there are many risks associated with borrowing money to invest — and that’s if your lender allows you to use personal loan funds to invest in the first place.
We’ll review what you should consider before using a personal loan to invest.
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- Can I get a personal loan for investing?
- Should I use a personal loan to invest?
- What’s next: Take stock of your situation before you borrow to invest
Can I get a personal loan for investing?
Personal loans are among the most versatile types of loans because you can often use the funds for just about anything you want.
However, some lenders may have restrictions on how you can use the money you receive. For example, you may not be able to use the money to start a business or consolidate student loan debt. It’s generally possible to take out a personal loan and invest the funds in the stock market, mutual funds or other assets, but some lenders may prohibit you from doing so.
Among popular online lenders, SoFi, LightStream and Upgrade explicitly exclude investing as an acceptable way to use your personal loan funds.
Before you apply for a loan, it’s important to shop around and compare multiple options. During that process, contact each lender and ask about limitations on how you can use the loan funds.
If you get a personal loan and the lender has explicitly prohibited using the loan funds for investing, doing so would put you in violation of the loan agreement. If that occurs, you could be forced to pay back the full debt immediately.
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Should I use a personal loan to invest?
Even if you can get a personal loan from a lender that allows you to invest the funds, there are a number of items you’ll want to consider before you proceed.
- Your credit — If you have strong credit and can get a low enough interest rate to make the investment worthwhile, you may want to consider it. If you have bad credit, you’ll have a hard time getting a low enough interest rate to make it pay off.
- Your income — If you’re investing in yourself by pursuing a professional certification that could improve your career options or income, it could be worth borrowing money to make it happen. The same may be true if you want to invest in your small business.
- You can afford the risk — Virtually no investment opportunity comes without risk, so even if you’re confident in the likelihood of a solid return, it’s important to prepare for a loss. If you can financially take that loss without missing a beat on your monthly payments, it could be a way to leverage your money.
That said, there are quite a few potential pitfalls to watch out for.
- The investment may fail — Your investment may not pan out how you’d hoped, and in extreme cases, you could lose all of your money. If this happens, you still need to pay off the debt, and if you can’t, it could significantly damage your credit history.
- Your loan rate could outpace your return — While you may think a personal loan is a good bet because the interest rate is lower than the historical returns of an investment, past performance of an investment doesn’t guarantee future results. If you don’t make enough from the investment to cover the interest charges and origination fees on the loan, you’ll end up with less money than when you started.
- Taxes — When you sell an investment, you may be subject to a short- or long-term capital gains tax. This tax eats into your effective return and could result in your losing money after interest and fees on the loan.
- A negative return could put you “under water” on your loan — If your plan is to pay off the loan with one payment once you’ve achieved your investment goal, you may be in for a surprise if the investment doesn’t go as well as you wanted. If it ends up being lower than the loan balance, you’ll have to come up with the remaining balance another way.
- Unexpected problems could ruin your plans — If you lose your job or run into another major financial emergency, you may need to liquidate your investment to cover your expenses. In this scenario, your personal loan payment will still be due, and you may not have the income to pay it.
If you’re thinking about using a personal loan for investing, it’s crucial that you think about both the benefits and the risks before you apply.
What’s next: Take stock of your situation before you borrow to invest
Now that you understand both the advantages and disadvantages of using a personal loan for investing, it’s important to apply them to your specific situation.
To start, you’ll want to get an idea of what current interest rates look like, particularly for your credit situation. Many personal loan lenders allow you to get prequalified before you submit an application, so you can view loan offers without a hard credit check.
This process can help you determine which lender may give you the best interest rate. If your credit needs some work, take time to build your credit before you continue.
Even if you can get a low interest rate, though, you’ll need to think about how averse you are to risk. If you’re worried about losing money on your investment and the consequences that ensue, it may not be worth it. But if you generally have a low aversion to risk with investing, think about how much you can afford in both the best and worst-case scenarios.
Finally, it’s important to make an honest assessment of your experience with investing. It’s easy to get caught up in the excitement over a particular investment opportunity, and you may worry about missing out on big gains.
But if you don’t have a lot of experience or expertise with this particular opportunity or investing in general, you may be better off waiting and developing some experience before you take such a big risk.
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About the author: Ben Luthi is a personal finance freelance writer and credit cards expert. He holds a bachelor’s degree in business management and finance from Brigham Young University. In addition to Credit Karma, you can find his wo… Read more.
