Borrowing to buy investments can be an effective way to boost your potential returns. This is called using leverage. As long as your investment increases at a rate that is higher than your borrowing costs, you can make money. But taking on debt involves more risk than paying for an investment outright with cash.
1. Take out a loan or line of credit
You may be able to get a loan or line of credit from your financial institution. The interest rate will depend on:
- how much you borrow
- what kind of loan you get, and whether you put up collateral or not
- the term of the loan
- your credit rating.
2. Borrow against your home equity
You can refinance your mortgage or take out a new mortgage. The hope is that the investment will not only cover the loan and related borrowing costs, but also generate extra income. The downside is that you could be putting your equity, and possibly your home, at risk.
3. Buy on margin
When you buy on margin, you borrow money from your investment firm to pay for part of your investments. Margin investing is very risky — you could lose more money than you originally invested.
4. Short sell stocks
When you short sell a stock, you borrow shares from your investment firm because you think that the price of the stock is going to fall. But if the stock price rises, you could lose more money than you originally invested.
Whether your investment makes money or not, you still have to pay back the loan plus interest. If you rely solely on investment returns to cover your borrowing costs and your investment falls in value, you could end up defaulting on the loan. If you put up your home, or other investments, as collateral for the loan, you could lose them as well.
3 things to consider
- Interest rates – What are the current rates? The higher the rate, the more it will cost you to borrow.
- Your level of debt – Do you have other high-interest debt? If you're already paying high interest on credit card debts, for example, your priority will likely be to pay down this debt as quickly as possible – and not take on more debt. Learn more about managing debt.
- Paying back the loan – Can you afford to make the loan payments on time, and pay back the loan quickly? If you can't pay back the loan within a reasonable period, it probably doesn't make sense to add more to your overall debt load.
8 questions to ask yourself
- Are you comfortable going into debt for an investment that may fluctuate in value?
- Can you afford to lose the collateral you put up for the loan? Any asset used as collateral, including your home, can be taken by the creditor to satisfy the loan.
- How will you pay for the loan if your investments fall in value? Do you have a secure salary, a cash reserve or other sources of income?
- What are the terms for repaying the loan and interest?
- Are there any other fees associated with the loan?
- Are the investments you’re buying with borrowed money suitable for your goals and risk tolerance?
- How much will you have to pay in commissions and fees?
- What are the tax consequences? Depending on what you invest in, you may be able to deduct the interest on money you borrow to invest.
Thinking about borrowing to make an RRSP contribution?
You’ll get a tax deduction for your contribution, but make sure you can afford the loan payments. Interest you pay on money you borrow to invest in an RRSP is not deductible. It can add up and offset the initial benefit of making the contribution. Learn more about borrowing to invest in your RRSP