Should you use a personal loan to invest and build wealth?

Whether you’re planning a major purchase or paying for emergency home repairs, a personal loan is a useful tool. Since money from personal loans can be used for almost any purpose, you might even consider using one for investing. Although it is an option, using personal loans for investing also comes with serious risks.

Can I use personal loans to invest?

You can invest with a personal loan, but that is not without risk.

The short answer is yes: it is possible to use a personal loan to invest. When you take out a loan, the money is provided all at once and you can use it for almost anything you want. Read the fine print carefully before signing up, as some lenders may prohibit the use of proceeds for specific types of investments, such as the purchase of stocks, mutual funds or similar investments.

Even in cases where you are allowed to use the proceeds to invest, it may not be wise to do so. Investing involves risks, including the possibility that you could lose your money completely. These types of outcomes can put you in a difficult situation if you plan to use the investment returns to repay the loan.

When is it wise to take out a personal loan to invest?

Using a personal loan to make the right type of investments can help improve your financial well-being.

You strive for career growth

In some professions, earning a promotion or receiving a more lucrative job offer may require a special certification or professional license. Because traditional student loans generally do not cover continuing education, a personal loan may be one of your only options for investing in career development.

Obtaining a personal loan for these types of investments in your future may make sense if it increases your chances of earning a competitive income. Check the US Bureau of Labor Statistics’ Labor Outlook Handbook to learn more about job growth projections and average salaries in your field so you can determine whether such an investment is worth it.

The downside to using personal loans to invest in continuing education is that you generally pay a higher interest rate than on a student loan. If you are in a continuing education program at least half the time, it may be worth exploring direct, unsubsidized loans from the federal government, which offer lower interest rates.

You increase your income

Many people increase their monthly income by turning their hobbies and passion projects into a side hustle or small business. If you want to start your own side business, a personal loan can provide the financing you need to get started

Using a personal loan to invest in a side income or to increase your income can be a wise investment if you take the time to develop a good business plan and ensure you have thought about how you will generate income and repay the loan.

It can be easier to qualify for a personal loan to invest in a passion project than to qualify for a business loan. Before choosing this approach, review all your financing options and find the choice that is most cost-effective. This should include finding the option that charges the least interest and the most favorable repayment terms for your financial needs.

You have excellent credit

Your credit score is one of the biggest factors affecting how much borrowing a personal loan will cost you. If you have an excellent credit score, for example a FICO score above 800, you have a better chance of qualifying for the lowest interest rate from a lender, and you may not lose as much of your investment.

When you qualify for the most competitive interest rates, you’ll pay less interest over the life of the loan. This means that borrowing the money costs you much less and therefore entails less risk.

You can pay the monthly payment

Consider whether you feel financially comfortable paying the monthly loan payment regardless of how your investment performs.

Take into account any existing debts you’re paying back now and other goals you’re saving for, such as saving for a down payment on a house. If, after running the numbers and carefully looking at your budget, you’re still confident in your ability to repay the loan, this could be an option for you.

However, if you can comfortably afford the monthly payments, consider putting that money in a high-yield savings account until you can afford to pay for the investment out of pocket. This eliminates any risk associated with taking out a personal loan, as well as interest costs.

Yet another alternative is fractional investing, where you can use the money you would have otherwise spent on monthly personal loan payments to gradually buy into investments. This option also allows you to avoid the interest and risks associated with a personal loan.

When is it a bad idea to take out a personal loan for investing?

Unfortunately, risky investments, a lower credit score, or a shorter window before retirement mean taking out a personal loan can be costly to your finances.

The investment is risky

When an investment has a higher than average chance of underperforming or delivering above average returns in a short period of time, it is considered a high-risk investment. For example, investing in the stock market is considered very risky. Adding debt to your investment portfolio makes your investment strategy more volatile overall.

Your credit score is average

If you don’t have excellent credit, you won’t qualify for a lender’s lowest advertised loan rate. With some personal loan rates reaching as high as 35.99 percent APR, the cost of the loan could exceed your potential investment return. In addition, there will be fewer lenders who are likely to want to give you a loan. It may be worth spending some time improving your credit before applying for a loan, if your credit score is reasonable, so that you are offered better rates and lower costs.

You cannot afford a failed investment

If you need the investment to get the suggested return to pay off your personal loan, this route is a bad idea. No investment can guarantee a 100 percent return, and you will have to start repaying your personal loan immediately, with interest.

There are also late fees if you fall behind on your monthly payments. A better idea is to explore options with less risk and volatility, such as money market accounts.

You are confronted with high costs

Before taking out a personal loan, make sure you know all the associated costs. Origination fees, which are fees charged in advance to process your loan application, can be up to 10 percent of your loan amount.

These aren’t the only costs associated with personal loans. You may also be charged late payment fees and fees for paying off the loan early. All of these costs can ultimately take away from the profits you can make from an investment. It may be wiser to save over time to invest rather than incurring additional costs.

You are at or near retirement

As you approach the end of your working life, you should aim to reduce your expenses. Adding debt like a personal loan when your income drops can jeopardize your retirement savings.

You may also face more serious problems if the investment doesn’t pay off and you can’t pay off the loan. Your credit score will be affected and you may face lawsuits from lenders, which could further erode your retirement savings.

What you should pay attention to before you borrow to invest

Here are some factors to consider so you have the best chance of making an informed decision.

Knowledge of investments

Investing is a smart way to grow your money, but there are a number of ways to do this. Different approaches have different levels of risk and volatility. Before borrowing money to invest, make sure you are fully aware of the different types of investments you can finance and their risk levels.

Bank deposit products, such as money market accounts and savings accounts, are considered low-risk investments because they are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA). These investment vehicles offer lower returns because they involve low risk.

Current loan rates

Financial institutions and lenders often determine their interest rates based on the federal funds rate. If the economy is in a slump, the Federal Reserve can cut the fed funds rate. While lenders can charge whatever they want for a personal loan, a lower federal funds rate could reflect lower interest rates on consumer loans in general.

Financial portfolio

Borrowing to invest is a step that requires a good understanding of the market, the risks and returns of each investment instrument and a good understanding of your risk tolerance. Debt from a personal loan can complicate your investment strategy. Consult with an investment advisor to determine whether taking out a personal loan makes sense.

Your personal risk tolerance

Before you decide to use a personal loan to invest, it’s important to seriously consider your comfort level with potential losses. Consider your risk tolerance and whether a safer or more aggressive investment strategy suits your needs.

it comes down to

Using personal loans to invest is not for everyone. There is always a risk that your investment will not yield the expected return. Other events, such as an unexpected layoff or a hospital bill, can also derail your monthly finances, making it difficult to repay the loan.

If you are in a stable financial position, have spoken to an investment professional and think borrowing to invest is the right choice, be sure to compare different types of personal loan providers. Whether you go through a traditional financial institution, online lender, or peer-to-peer lender, each lender has different terms, rates, and fees that you’ll want to evaluate.