When is it right to borrow for investments? ó Borrowing money to invest can help grow your money, but it can also lead to larger losses and is not suitable for all investors. An investor must meet certain suitability criteria before a financial adviser recommends leveraging.
How Does it Work?
- Take a loan from a bank or lending institution
If you use the equity in your home to secure this loan and the investment doesnít work out, you may have to sell your home to pay back the loan. If the investment is used as collateral for the loan and it drops in value, you still have to make payments on the loan. And, you may be required to provide additional collateral to make up the difference.
- Borrow money through a brokerage firm
This is also known as buying on margin. Have a back-up plan because you will have to put more of your own money into your margin account if the investment loses money.
Three Key points to consider before borrowing money to invest:
- You could lose money.
Whether your leveraged investment makes money or not, you still have to pay back the loan, plus interest.
- It may cost more to invest.
Even if your leveraged investment makes money, you donít get to keep it all. You still have to pay the interest costs on the loan. These could be higher than your returns. There can also be set-up fees, on-going maintenance fees and a fee for early withdrawal of the loan or the investment.
- You could damage your credit.
If you are relying on the returns from leveraged investments to cover the cost of borrowing, you could default on the loan if the value of the investment decreases.
The risks of borrowing to invest are high. Be sure to fully understand all associated borrowing costs before making any final decision and be ready to cover any potential losses with other savings.