Borrowing To Invest: The Ultimate Beginner’s Guide To Investment Loans

Borrowing money to invest, also known as ‘gearing’ or ‘leverage’, can help you accelerate your wealth.

It allows you to buy assets such as an investment property or shares that you may not be able to afford outright.

Shares are also known as equities or stocks.

Borrowing to invest is a high-risk strategy that is dependent upon which direction the market goes.

While you may gain large returns when the markets go up, you may also gain larger losses if markets fall.

Below is a guide on everything you need to know about borrowing to invest: why borrow to invest, how it works and managing the risks involved.

Why Borrow to Invest?

Borrowing to invest can allow you to:

Increase the size of your investment portfolio.An investment portfolio may help you to grow your wealth at a faster rate.

• Diversify your investments to prevent losses in one investment so that it can be offset by gains in another.
• Reduce your taxable income when the loan is used to invest in managed funds or shares.

Managed funds are an investment fund where your money, including that of other investments, is pooled and used to buy assets such as cash, shares, bonds and listed property trusts.

Borrowing to Invest: How It Works

Borrowing to invest is a medium to long-term strategy of at least 5 to 10 years.

Typically, this strategy is carried out through margin loans for shares or investment property loans.

Before you borrow to invest, you’ll need to know about positive and negative gearing.

Borrowing to Invest: Gearing and Tax

You’ll need to assess if you’ll be positively or negatively geared, and how this will impact your cash flow and tax.

Positive Gearing

Positive gearing is where you borrow money to invest and the income from that investment (for example, rent) is more than the cost of the investment (interest and other expenses).

If you’re positively geared, you’ll have extra money coming in.

Though, you’ll have to pay tax on this income.

Negative Gearing

Negative gearing is where you borrow to invest and the income from that investment is less than the cost of the investment.

Investors negatively gear as they can generally claim a tax deduction for the investment loss.

The reason is for capital growth to offset the loss in earlier years.

An investment loss is costing you money, therefore, you’ll need to have cash from other sources (salary) to cover the interest and other expenses.

Now that you know about gearing and tax, below are ways to use your investment loan.

Borrowing to Invest in Shares using Margin Loans

A margin loan allows you to borrow money to invest in shares, managed funds and exchange-traded funds.

Exchange-traded funds (ETFs) are a managed fund or unit trust that is quoted and traded on a stock exchange such as the ASX.

ETFs imitate the performance of a specific index such as the S&P/ASX 200 index, AUD currency or a commodity such as gold.

Margin lenders require you to keep the loan-to-value ratio (LVR) below an agreed level, which is usually at 70%.

The loan-to-value ratio = value of your loan / value of your investments.

The LVR goes up if your investments fall in value or if your loan increases.

If your LVR goes above the agreed value, you’ll get a margin call.

A margin call is when the lender will ask you to deposit enough money to bring the loan back to the agreed valued. 

To lower your LVR, consider the following options:

• Deposit money to reduce your margin loan balance.
• Add more shares or managed funds to increase your portfolio value.
• Sell part of your portfolio and pay off part of your loan balance.

If you can’t lower your LVR for whatever reason, your margin lender will sell a portion of your investment on your behalf.

Borrowing to Invest in Property

Property investment is often viewed as being less risky than other investment methods.

Investment property loans can be used to invest in land, houses, apartments or commercial property.

You earn an income through rent, however, you have to pay interest and the costs to own the property.

There’s no doubt that buying, managing and selling an investment property can be costly.

Moreover, it will affect your overall return.

Below summarises the costs of purchasing and selling a property.

Purchasing a property

• Stamp duty
• Conveyancing fees
• Legal costs
• Search fees
• Pest and building inspections

Selling a property

• Agent’s fee
• Advertising costs
• Legal fees

It’s important to note that you may be required to pay Capital Gain’s Tax if the property has increased in value.

Ongoing Costs of Investing in Property

Below summarises the ongoing costs of investing in property:

• Council and water rates
• Building insurance
• Landlord insurance
• Body corporate fees
• Land tax
• Property management fees (only applies when you use an agent)
• Repairs and maintenance costs.

Borrowing to Invest: The Risks

Borrowing to invest can help increase your returns or allow you to buy larger investments.

However, the more you borrow, the more you can lose.

Below are the major risks of borrowing to invest:

High losses

Every time you borrow to invest, you increase the amount you’ll lose should your investment fall in value.

You need to repay the loan and interest regardless of how your investment goes.

Capital risk

The value of your investment can depreciate.

The loan balance may not be covered should you find the need to sell the investment quickly.

Investment income risk

Unexpected scenarios such as a renter breaking a lease or a company going into liquidation may not provide the investment income that you expect.

Always make sure you can cover living costs and loan repayments in any case.

Interest rate risk

If you have a variable rate loan, the interest rate and payment can increase.

Make sure you can afford the repayments for times when interest rates go up.

Remember, borrowing to invest only makes sense if the return (after tax) is greater than the costs of the investment and loan combined.

If not, then you’re taking on a lot of risk for a low or negative return.

Do not use your home as security. If your investment fails to provide an income and you can’t keep up with the repayments, you could lose your home.

Borrowing to Invest: 5 Tips on Managing the Risks

If you decide to borrow to invest, below are tips to help you get the right investment and protect yourself against large losses.

1) Shop around for the best investment loan

Be prepared to do the research yourself and not just rely on trading platforms or recommendations from your lender.

2) Don’t get the maximum loan amount

As tempting as it is, the more you borrow, the bigger the interest repayments and potential losses are.

Always borrow less than the maximum amount the lender offers.

3) Pay the interest

As straightforward as that is, making interest repayments will prevent your loan and interest payments increasing each month.

4) Have cash

Establish an emergency fund or cash you can quickly access. Put simply, you don’t want to have to sell your investments if you need cash quickly.

5) Diversify your investments

Diversification will help you to protect yourself against unfortunate circumstances such as a single company or investment falls in value.

Final Word:

Borrowing to invest is a high-risk strategy for investors. Always speak to a financial adviser to know if this is the right strategy for you.

Have you thought about an investment loan? If so, would you use it to purchasing a house or shares?

Are you in need of financial advice? Phone me, Benjamin Collins on (07) 3041 1382. Alternatively, send me a message on LinkedIn.