You want to build wealth beyond parking your cash in a low-interest savings account but you can’t afford to buy an investment property.
And building a share portfolio is appealing but you don’t have a huge amount of money to get started, so should you borrow to invest?
There are several different ways you can borrow to invest in the sharemarket and in each case the shorter your timeframe, the higher your risk.
Creo Wealth practice manager Kylie Sultana said before considering borrowing to invest, you must have a strategy in place.
“The first thing I would be looking at is what is your goal, how long do you want to be invested in the sharemarket, what’s your ultimate plan,” she said.
“There is no point borrowing money if you have no plan.”
So what are the options if you want to borrow to invest?
This path is not for the faint-hearted because you are borrowing against the shares you buy and things could rapidly go haywire if you’re not careful.
If you get a margin loan, your investment is used as security for your loan.
Banks will set a loan-to-value ratio (LVR), which is how much they will lend you as a percentage of the value of the shares.
Creo Wealth financial adviser Anthony Sultana said the LVR on a margin loan is usually between 60 to 70 per cent of the shares’ value.
But you have to be prepared to fork out more cash if the value of your investments dives, or you risk having to sell at a loss.
If the value of your shares falls and drives down the LVR below the level agreed with your lender, then they can make a margin call.
This means that to bring the loan back to the agreed LVR, you have to deposit more money into your account, add more shares to boost your portfolio value, or sell your shares.
So to avoid having to sell your shares when the market is down, it is wise to have cash ready in advance should a margin call arise.
“You don’t want to be selling the shares when the markets go down because it makes your losses greater, so it could end up being disastrous if you don’t plan it well,” Mr Sultana said.
Most margin loans are interest only, meaning you only have to service the interest and don’t have to make regular loan repayments, and they can have variable or fixed interest rates.
Interest paid on a margin loan is generally tax-deductible.
Is there a less risky way to borrow?
If you have a mortgage, you can draw on some of the equity you’ve got in your home to invest in shares.
“If the markets go down, you don’t have to make any extra repayments because obviously the lender has got your home as security, which will be worth more than the value of shares that you’re buying,” Mr Sultana said.
Investment loans are another option and work in a similar way to home loans, in that you pay off the principal loan, plus interest, every month.
A key benefit of an investment loan is you don’t have the stress of borrowing against your home.
But if you miss a repayment, your investments may be sold and if the interest rate climbs, your repayments may be more than what you budgeted for, so it’s important to factor in future interest rate rises when deciding whether an investment loan will suit your needs.