Borrowing to invest: What you need to know

Borrowing to invest can offer access to funds as a means to increase your purchasing power. There may also be tax benefits, such as deductions on income, if you’re on a high marginal tax rate.

However, borrowing to invest can be a risky financial strategy. The property market often experiences lengthy stretches of flat price movements, while the share market can be wildly volatile and unpredictable.

Before you consider an investment loan, you should ensure that you can service the costs, including repayment of the principal and any interest owed. It may be sensible to seek professional financial and tax advice with respect to the potential risks and benefits of positively geared and negatively geared investments.

Loans to buy property

If you're looking at buying your first home for investment you’ll likely need an investor loan.

These types of loans are different to home loans for owner occupiers. Investor home loans are more likely to have features and benefits that property investors may find useful, such as an offset account, additional repayments, a redraw facility, or the option to make interest-only repayments for a limited time.

As with any investment, there are risks involved when investing in property. You may have trouble attracting tenants, the property could be damaged, or home values in your area might stagnate or decline.

Owner occupiers are often seen as highly motivated to keep a roof over their head, while investors may be more open to taking financial risks to help maximise their returns. As a result, investment borrowers may be subjected to tighter, more stringent lending criteria and are more likely to incur higher interest rates and fees.

As is the case when applying for an owner occupier home loan, you’ll need to pay a deposit on an investor mortgage. However, it’s often more difficult to find low-deposit investor loans, and much more likely that you’ll need to pay an upfront deposit of 20 percent or more of the property’s value as part of the eligibility criteria.

Achieving the best interest rate as a property investor often requires you to demonstrate that you’re a reliable borrower. The less risk you represent to a lender, the more likely you are to be offered a lower interest rate on your mortgage. The larger a deposit you can afford on your mortgage, the more likely you are to be offered a lower interest rate. If you already own another property, you may be able to use your equity in place of saving up a deposit.

It’s important to compare different investment loan products before you make an application, so you can see which rates, fees, features and benefits may best suit your needs. You may also want to contact a mortgage broker or financial adviser to work out the best property investment strategy to meet your goals.

Loans to invest in equities

Borrowing to buy equities (aka shares, stocks, or securities) as an investment strategy can seem daunting and complex, especially if you’re unfamiliar with share markets.

There are many ways to invest in equities. If you wish to personally select which shares you buy and sell, an online broking service can facilitate your transactions for relatively low fees per transaction. A full-service stockbroker will likely charge you more, but may be able to provide personalised advice, which could be valuable if you’re not sure where to invest.

The minimum amount you can invest on the Australian Stock Exchange (ASX) is $500. A personal loan may be an appropriate borrowing facility for this type of investment strategy.

Alternatively, staking a small portion of funds, or micro-investing, in a variety of assets could potentially be a way to grow your capital, while trying something new and risking a lot less.

You may also consider exchange-traded funds (ETFs) as a sensible way to diversify your investments to reduce your risk. An ETF or index fund is an investment product that lets you simultaneously hold a mix of stocks, usually affiliated with a particular market, industry or sector. Some index funds offer nontraditional investment options, such as ETFs supporting renewable energy projects and sustainable business practices.

Margin loans to invest in shares

Margin loans function much like personal loans or credit cards, where you pay interest on the money you borrow. Margin lenders often limit how much you can borrow by evaluating the value of shares you wish to purchase - this is known as the Loan to Value Ratio (LVR). This measures your risk to ensure you’re not over-borrowing.

The sharemarket can be quite volatile and you may experience a decrease in share values. If your value falls to where LVR exceeds a predetermined level, you may be required to top-up your loan collateral or repay a portion of the loan. This is known as a margin call.

If a margin call is not met within a timeframe set by the lender, your shares may be sold to satisfy your obligations. If this happens, you may incur a loss on your investment.

Loans to invest in bonds

When investing in bonds, you’re essentially lending money to a government or corporate entity in exchange for regular interest returns, known as coupon payments.

These types of investments are often considered low-risk, defensive assets but remain exposed to interest rate rises and credit defaults and insolvencies.

All bonds have a face value when first issued. If you hold the bond until maturity you’ll receive this principal amount, plus interest accrued over time. If you sell a bond before maturity, you’ll obtain the market value. This may be lower than the face value and is dependent upon interest rate movements, credit risk of the issuer, liquidity levels and investment duration.

Government bonds

Australian Government Bonds (AGBs), also known as Treasury Bonds, are issued by the Australian government and guarantee a rate of return if held until maturity.

Exchange-traded Treasury Bonds (eTBs) offer fixed interest payments, while Exchange-traded Treasury Indexed Bonds (eTIBs) provide interest payments linked to inflation.

You can buy and sell listed AGBs on the Australian Securities Exchange (ASX) at market value. Be aware that there are brokerage fees attached to these purchases.

Semi-government bonds (Semis) represent semi-sovereign debt and are issued by Australian states and territories. They can only be bought and sold through state and territory treasury corporations.

To find out more, the Australian Securities Exchange (ASX) offers an online Government Bonds course.

Corporate bonds

When a company wants to raise money from investors to finance their business activities they can issue corporate bonds, typically bought and sold on the over-the-counter (OTC) market.

These investments are typically reserved for wealthier investors as the minimum amount required to buy corporate bonds is generally quite significant, ranging up to $500,000.

Consider your risk appetite before investing. If the company you buy bonds from goes broke, you won't receive coupon payments and may not see your face value returned.

Should I borrow to invest?

You may not have the cash outright to acquire assets such as properties, shares and bonds. Borrowing to invest can provide the opportunity to establish or grow your portfolio and accumulate wealth.

There are a raft of other investment options you might consider, including investing in your own business or that of a family member or friend; foreign currency exchange (forex); buying and holding cryptocurrency; green investments; and much more.

Before borrowing to invest, consider these questions:

• How much are you willing to risk?
• How safe is the investment platform?
• Have you built a diverse portfolio?
• When do you expect to see a return on investment (ROI)?

Typically, an investment is a long-term holding that is intended to deliver dividends over time.

If you’ve acquired a home loan and, over time, built up additional equity, some lenders will allow you to borrow to invest using your home as security. The Australian Securities & Investments Commission (ASIC) Moneysmart platform warns against this action in reference to first home buyers and owner occupiers:

“Do not do this. If the investment turns bad and you can't keep up with repayments you could lose your home.”

Past performance is not a reliable indicator of future performance, though it's sensible to conduct research.

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