Written by: Guest | Best Company Editorial Team
Last Updated: February 24th, 2020
Guest Post by Natalie Issa
A new investment opportunity beckons, but you don't have the cash flow to dip into it. Could a personal loan be the right way to fund the endeavor?
"You have to spend money to make money" is a common mantra of successful entrepreneurs and investors, and it's not wrong. And sometimes, you have to spend someone else's money and pay that back before you can make money. Plenty of small businesses were born on the backs of credit cards or personal loans. But whether taking out a personal loan to invest makes sense depends on factors such as loan and investment terms and a little bit of luck.
Understanding the math
Whether or not you should make an investment of any type typically comes down to a single question: Will it be profitable? If you're borrowing money to make the investment, you have to consider the cost of the loan in the equation.
For example, the Best Egg personal loan comes with an APR of 5.99 percent to 29.99 percent for qualified applicants. Your credit score and other factors determine whether you're approved for this type of personal loan and what the interest rate and terms might be. Let's consider the best — and worst — case interest rates for this particular loan and how that stacks up when investing in various options.
- Returns on 5-year CD are under 3 percent. Since the interest you earn is less than the interest you pay out at either 5.99 percent or 29.99 percent, this is obviously not a scheme that pays. And since personal loans tend to come with fixed interest rates, that's not a truth likely to change. Money market mutual funds have average returns ranging from 1.76 percent to 4.54 percent. Again, if you're paying the interest on a personal loan, you'll pay more out than you earn.
- Some high-yield bond funds can yield rates as high as 8.93 percent. If you can get the best personal loan rates and luck out with high-yield bonds, you could turn a 3 percent profit.
- With a bit of knowledge and some luck, you might be able to turn a personal loan into a winning investment in the stock market. For example, if someone took out a personal loan for $5,000 in 1997 and used it to purchase 277 shares in Amazon at $18 a pop, they would now have more than $500,000 worth of shares. That's much more than any interest rate paid on the $5,000 personal loan. However, the stock market does work the other way. If someone purchased Ford stock in 1997 instead of Amazon, they would currently be holding a $5 per share loss — with no profit at all, much less enough profit to cover fees and interest rates on a personal loan.
When you consider taking out a personal loan to invest, make sure you're running all the numbers. In addition to comparing interest rates between the loan and your investment, consider any other costs of the loan and whether you can make timely payments on it even before you investment pans out.
Want to know your credit score to get an idea of what interest rate you'll pay on a loan so you can consider the math on an investment opportunity? Get it for free on Credit.com.
When it makes more sense to do something else
Investing the cash from a personal loan may not be the best way to maximize the value you can get from it. In some cases, using the funds from a personal loan to consolidate higher-interest credit card or other debt actually nets you more money via savings.
For example, consider a credit card balance of $3,000 with an APR of 15 percent . If you can shop around for a personal loan that works for you and get approved for one with 6 percent APR, you can save a lot of money while paying off your debt.
- If you make payments of $100 a month on a credit card with a $3,000 balance and 15 percent interest, you'll pay in total $3,783.57.
- If you make payments of $100 a month on a personal loan of $3,000 with an APR of 6 percent, you'll pay in total $3,258.56.
- That's a savings of more than $500.
Aside from the ability to save money, one of the benefits of using a personal loan to consolidate debt is that you're more likely to get the financial value you expect. All you have to do is hold up your end of the "bargain" by making the appropriate payments on your personal loan. As long as the terms and math line up in your favor, you will benefit from the savings.
You don't get the same guarantee when you're investing. You can do everything correctly and still not come out ahead when you're playing the stock market. So, it's a good idea to avoid taking out personal loans to invest unless you're very sure about the opportunity.
The TL;DR on personal loans and investing
If you have very good credit and are approved for personal loans at very low interest rates, you could profit by investing in opportunities that have higher interest rates than your loan does. For most people and investment situations, this can be risky. The biggest opportunity for profit comes from the stock market, but you won't know whether you've succeeded for potentially years. However, you can succeed immediately and save money by using personal loans to consolidate higher interest credit.
Whether you're willing to gamble, paying to play for profit with investments, or you want to get a handle on debt and pay it off faster, personal loans can be a valuable tool. Check out all the options and apply for a personal loan today.
Natalie Issa is a content specialist for Credit.com. Her experience spans working with a variety of content, including blog posts and journalistic articles, as well as film and podcasts. She’s applied her writing and editing expertise in the retail and digital industries at companies such as Overstock.com and Deseret Digital Media, while applying her creativity to passion projects in her personal time.