Borrowing, or gearing as it is commonly referred to is a great strategy to help you accumulate wealth. There are many different types of version of ‘borrowing to invest’ and you need to understand the complexities of each before you invest.
From a basic perspective, you borrow money from a lending provider (usually a bank) and then combine this money with yours to invest in an asset. The combined income and growth you receive needs to be greater than the interest expense (after tax) for it to be a worthwhile investment. The problem is however, the returns are never guaranteed so you are taking an educated gamble.
There are many different types of loans you can take out for an investments. Some of them are;
– Margin Loans – Typically used against shares
– Home Loans – Typically used to borrow against your home or investment
– Protected Equity Loans/Capital Guaranteed Loans – These are structured investments and come in many different forms. They typically bundle the debt and investment together
So how do you avoid the risks of ‘borrowing to invest’? Well you can’t eliminate the risk, you can only reduce or contain it. This might mean borrowing less that you originally wanted to, having a lump sum amount in a savings account that can cover your interest should you not be able to pay it, fix in rates to create certainty around the cash flow and take out insuruance to cover debt. Within other articles we examine each type of loan more specifically. Whichever you choose, just make sure it is right for you.