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Investing is a great way to increase your net worth and achieve your financial goals. You can often make a lot more out of your money by putting it in the stock market instead of keeping it in a savings account. Over the long term, the stock market offers an annual rate of return of around 10%, compared to 1% or less in a high-yield savings account.
If you are looking to increase the amount you invest, you may consider taking out a personal loan to add to your investment account. But that’s rarely a good idea.
Here’s why you generally shouldn’t take out a personal loan to invest, plus a few cases where it might make sense.
Why you should not take out a personal loan to invest
A Personal loan is a relatively small, unsecured installment loan that you repay at a fixed rate over three to seven years (sometimes longer). You usually don’t need to post collateral, but you do need to make a monthly payment until you’ve fully repaid the loan, plus interest. If you don’t, you risk damaging your credit score. Personal loan amounts often vary between $10,000 and $100,000, although some lenders also offer smaller loan amounts.
With investment, there is very little guarantee. The money you invest in the market can go up or down. You could even lose everything.
This difference makes using a personal loan for investing inherently risky, and generally a bad idea. In fact, some personal lenders even specifically prohibit you from using the money for investing. Here are some other reasons why you might be hesitant to use a personal loan to invest:
- The investment you are considering may lose value. When you invest, you risk losing money. Markets can crash, stocks can crash, and companies can go bankrupt. But when you take out a loan, you are obligated to repay the money and interest no matter what. Losing money on your investment can make it harder to repay your loan, exposing you to the serious financial consequences of missing payments.
- You have bad credit. When lenders set the interest rate you’ll pay on a personal loan, they take your credit score into account. People with excellent credit pay lower rates, while people with fair or poor credit will pay higher rates. If you belong to the latter category, your personal loan may be expensive. People with bad credit may struggle to find personal loans available to them. It can therefore be difficult to get enough return on an investment to cover the interest you have to pay on the loan, even under ideal circumstances.
- Your finances may change. With a personal loan, you will know from the start how much you will have to pay each month. This will not change for the duration of your loan. While this payment may be affordable when you take out the loan, your finances may change. You could lose your job or face an unexpected expense or financial emergency. A significant drop in your income or an increase in your expenses could make it more difficult to pay the monthly payments on your personal loan. If this is a possibility in your situation, it may not be a good idea to take out a personal loan to invest.
When taking out a personal loan to invest can make sense
Using a personal loan for investing is almost always a bad idea. However, in rare cases, it may make sense. Here are some scenarios where you might consider investing the funds from a personal loan:
- You could get a higher rate of return on your investment than you pay in interest. Using a personal loan for investing theoretically makes sense when you are able to safely earn a higher rate on your investment than you pay in interest, earning you money over the life of the loan. ready. However, few investments are safe, especially over the relatively short duration of your loan. If you find a safe investment, such as a certificate of deposit or savings bond, with an interest rate that is higher than the stated interest rate, it may be a good idea to give it a try.
- You can repay the loan early. If you owe a large sum of money, such as through an inheritance or house sale, you may be able to use a personal loan to start your investment and then pay off the loan quickly. Be careful though: some personal loans require you to pay a prepayment penalty if you repay your loan early.
- You can use the investment to generate income. Investments do not always mean stocks. You may be considering using a personal loan to start a new business, creating a way for you to earn money for years to come. This approach is not without risks, but they may be risks that you are willing to take.
Although borrowing money to invest is fraught with challenges, investing is still a good idea — it’s a great way to build long-term wealth and save for retirement.
Instead of taking out a personal loan and using the money to invest, consider these investment options:
- Pay off high-interest debt and invest savings. Personal loans can be a good way to reduce interest costs, especially if you have high interest debt like credit cards. You could take out a personal loan to pay off those other debts and use the interest savings toward investments.
- Increase your 401(k) or IRA contributions. Work-sponsored retirement plans are a great way to start investing. If you have a 401(k), consider increasing your monthly contribution. If you don’t have access to a work-sponsored retirement plan, you can open your own IRA to start saving for retirement.
- Learn about mutual funds. A mutual fund can be another good entry-level investment. The money you put in a mutual fund will be pooled with other investors’ money and used to buy stocks, bonds and other types of securities. Investors in the pool will share in any dividends or interest paid by the investments.
If you decide to apply for a personal loan, Credible allows you to compare personal loan rates from various lenders, all in one place.