Investment loan: Monzi investigates. Find out everything you might need to know with our comprehensive breakdown. Let’s go!
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Borrowing to invest: what is an investment loan?
An investment loan is simply a type of loan that a person takes out to fund the purchase of an investment. Typically, this investment will either take the form of shares (or other securities) or property.
Borrowing to invest is usually considered a high-risk strategy. While you may be able to increase your returns, if things don’t go as anticipated, the costs can soon become unmanageable. As a result, they’re typically a strategy only employed by experienced investors.
However, that’s just a basic overview. Read on and we’ll dig deeper into all the key details, considerations and features of loans for investing. So, let’s get into it.
How does an investment loan work?
In short, you borrow from a lender and use that money to invest in shares, managed funds or property.
From there, the idea is that the income received from your investment (e.g. share dividend or rent payment) is then used to help repay your loan. If the income you receive is greater than your repayment, then the investment is profitable.
Typically, these loans come in two forms. Both are quite different, however, we’ll explain more about that in a bit.
Finally, borrowing to invest is a medium to long-term investment strategy. So, don’t expect to see results overnight. If you invest successfully then you will see the benefits over time.
The types of investment loan
Borrowing to invest typically comes in two forms: margin loans and investment property loans.
In both cases, the loan is usually secured by the investment. In other words, if you are unable to make your repayments then the lender may be able to take possession of the investment and sell it, in order to recover their losses.
For a breakdown on each type of loan, check below:
A margin loan is a loan that allows you to fund the purchase of shares, exchange-traded-funds (ETFs) or a range of other financial securities.
One crucial thing to understand is the loan-to-value ratio (LVR). When you agree to your loan, your lender will outline the ratio that you must keep your loan below. Usually, this will be 70%, although it will vary.
In short, the LVR is equal to your loan value divided by the value of your investments. If your investment value falls or your loan value increases, your LVR will increase.
If it goes above the agreed level, you will have 24 hours to lower it. This can be done by reducing your loan balance, increasing your investments or selling some of the shares in your portfolio.
Margin loans are a risky investment. If unfavourable market movements occur, you can find yourself in a spot of financial bother. As a result, do your research and ensure this product is right for you before you apply.
Investment property loans
An investment property loan is just another kind of mortgage loan. You can invest in land, apartments, houses or even commercial spaces; it’s up to you.
As it’s an investment property, you receive income from rent which you can then put towards your interest repayments and the costs associated with owning a property (e.g. maintenance or tax).
This is a long-term commitment. Mortgage repayment terms can span decades so don’t think this will be a quick money-spinner. If it all goes to plan, the benefits will be seen over time.
Risks of investment loans
Taking out a loan obviously gives you more capital to invest. With this, it is possible to increase your returns or make larger investments. However, it’s not always positive.
Investments are inherently risky. After all, nobody can predict the future. While you may expect things to go one way, history is littered with horror stories of investments gone wrong. Unfavourable interest rate movements, market fluctuations or changes in the nation’s economic situation can all have dire financial consequences for you.
In short, the more you borrow, the more you can potentially lose. That’s why effective financial management is crucial.
Ultimately, the cost of borrowing shouldn’t exceed the returns you receive. Particularly when you consider the associated risks:
Interest rate risk
Got a variable interest rate on your loan? Unfavourable movements could leave you unable to make repayments. For example, if the rate jumps from 2.5% up to 5%, would it be affordable for you? One solution could be a fixed interest rate, however, there are pros and cons to all options.
Let’s say you purchase an investment property. Unfortunately, the value drops due to circumstances out of your control. If you then have to sell the property, the amount you receive may not be enough to pay off the balance of your loan.
Investment income risk
While you may have an idea of what your income may be, your forecasts aren’t always accurate. If your returns are lower than expected, you may be unable to afford your repayments. If the share market takes a hit or your company opts not to pay a dividend, you can find yourself in a world of hurt.
How do I get an investment loan?
This will depend on the type of loan that you’re after.
For margin loans, you may need to approach a stockbroker. However, there are plenty of banks that will offer these loans too. Shop around to find the loan that works best for you.
On the other hand, investment property loans will mainly be offered by your standard banks. Although, there may be some independent mortgage lenders who may be willing to help too.
Is it illegal to borrow money to invest?
No, so long as you apply for an investment loan. These loans are designed specifically to be used for this purpose. As a result, there are controls and processes in place to ensure they are offered in a responsible fashion.
On the other hand, if you are applying for another kind of loan (e.g. a personal loan) then using the money to invest, this is probably not an advisable strategy.
While it may not be illegal per se, when you apply, you will need to provide a reason for needing the money. If you list “investing”, your application may not be approved.
Is it hard to get an investment loan?
In short, they can be.
The qualifying criteria for loans tend to be more complicated and stricter than those applied to other loans (e.g. a regular mortgage). Moreover, investment loan rates are often higher and you may need to pay a greater deposit upfront in order to be granted the loan.
As a result, you will likely need to be in a secure financial position to be approved. This may include stable employment, an good credit report and owning other assets.
Can I afford an investment property?
This will depend on your unique financial situation. As a result, we cannot say if an investment property is affordable for you. Typically, you will need to pay a deposit of 20%. However, this may vary.
In any case, in order to make this decision, it’s usually smart to consider your complete financial situation as well as factors related to the investment.
If you’re looking to purchase an investment property then considerations can include:
- Your income, savings and expenses.
- Any outstanding debts (e.g. existing mortgages).
- The loan cost (fees, repayments, etc.)
- The tax implications (will it produce a saving?)
- Expected rent returns
- Household maintenance and other associated costs.
What should I invest $10,000 in?
Monzi cannot say what you should invest your money in. We are not financial advisers and will not provide you with any advice.
For qualified help, make an appointment with a financial adviser and they may be able to work with you to develop a plan. Alternatively, do your own research to find investments that may be worthwhile.
Investment loan rates Australia
Loan rates do vary due to the fact that they are calculated based on a number of factors.
For instance, the interest rate on share investment credit will likely be different from the rate on a loan for investment.
Moreover, your interest rate may depend on personal financial factors too. If you have a good credit score and have shown yourself to be a reliable borrower then you may be offered a lower rate than someone with bad credit.
In short, interest rates will vary.
Investment loan calculator
Keen to know what the costs will be? Do a quick Google search and you’ll find a range of online, free loan calculators which can help.
Just enter the amount you wish to borrow as well as the rates and repayment term. From that, the calculator will be able to provide you with an estimate of what your repayments may be.
However, this information is non-binding and only a guide to give you an idea of what your repayments may be.
How do I minimise the investment loan risks?
Proper financial management can help you avoid some of the risks associated with investment. However, a loan will never be totally risk-free.
In any case, key tips to reduce your risk include:
- Diversify: don’t put all your eggs in one basket. Hold a range of investment across a range of industries, commodities and securities. That way, if one investment doesn’t go to plan, you won’t lose everything.
- Find the right loan: compare the interest rate and fees to find the best deal. It might save you a ton of money.
- Only borrow as much as you can afford: don’t overextend yourself. Make sure the repayments are affordable.
- Keep some emergency cash: always have some cash on-hand in case you need to cover a loan repayment.
For further details, visit the borrowing to invest breakdown on MoneySmart.
Investment loans, gearing and tax implications
You’ve probably heard of the term ‘gearing.’ It simply refers to the process of borrowing to invest. Moreover, you’ll probably have seen the words ‘positive’ or ‘negative’ added too.
In short, positive gearing means the income you receive from your investment (e.g. rent) exceeds the cost of borrowing (e.g. interest repayments).
On the other hand, when you are negatively geared, the income you receive is less than the costs of borrowing. While this seems undesirable, it is often done intentionally.
The loss that is accumulated can be claimed as a tax-deduction thereby reducing their taxable income. This can make investing in property easier and more accessible for some investors.
Monzi: finding personal loans made simple
In short, we’ve tried to cover all the investment information you need. However, we don’t in fact offer these loans. That’s because we’re a lender-finder service.
That means we try to match borrowers with lenders in an efficient manner. Through Monzi, you may be able to access personal loans up to $10,000. Just submit one simple application and you might be paired with a great lender before you know it.
Think a personal loan is right for you? Apply with Monzi today.
Finally, to learn more about investing in your future, check out Monzi’s guide to superannuation today.