4 ways to borrow to invest
Borrowing to buy investments can be an effective way to boost your potential returns. This is called using leverageLeverage A way to make a larger investment by using borrowed money to invest. The more you invest, the more money you can make. But if things don’t work out, you will have bigger losses.+ read full definition. As long as your investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition increases at a rate that is higher than your borrowing costs, you can make money. But taking on debtDebt Money that you have borrowed. You must repay the loan, with interest, by a set date.+ read full definition 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 rateInterest rate A fee you pay to borrow money. Or, a fee you get to lend it. Often shown as an annual percentage rate, like 5%. Examples: If you get a loan, you pay interest. If you buy a GIC, the bank pays you interest. It uses your money until you need it back.+ read full definition will depend on:
- how much you borrow
- what kind of loanLoan An agreement to borrow money for a set period of time. You agree to pay back the full amount, plus interest, by a set date.+ read full definition you get, and whether you put up collateralCollateral Property or assets that you pledge as a borrower as a guarantee that you will repay the loan. You may lose your collateral if you don’t pay back your loan.+ read full definition or not
- the termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition of the loan
- your credit rating.
2. Borrow against your home equity
You can refinance your mortgageMortgage A loan that you get to pay for a home or other property. Often the loan is for 20 years or more. You make a set number of payments for a set amount each year.+ read full definition 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 equityEquity Two meanings: 1. The part of investment you have paid for in cash. Example: you may have equity in a home or a business. 2. Investments in the stock market. Example: equity mutual funds.+ read full definition, 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. MarginMargin A way to buy investments by borrowing money from a stockbroker. You must also invest some of your own money first. The extra that you borrow is your margin. Some rules apply about the size of margin that you can have.+ read full definition investing is very risky — you could lose more money than you originally invested.
4. Short sell stocks
When you short sell a stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition, 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.
Borrowing to invest can be an effective strategy, but it’s not for everyone. Taking on this kind of debt can be very risky.
Use this calculator to see how long it will take you to pay down debt at different interest rates.
If you’re thinking about borrowing to investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition, read these tips before making your decision.