You’re undoubtedly familiar with many of the most common reasons people take out personal loans. Things like debt consolidation, medical expenses, large purchases (cars or appliances), weddings and honeymoons, and home improvements are valid reasons for securing a personal loan. In these cases, the loan funds are used to pay for expenses. However, there’s another reason for securing a personal loan. While not as common, a personal loan to invest in financial markets is also valid for securing a loan. This type of personal loan is worth considering since it can help one grow their capital.
Can a Personal Loan be Used for Investing?
There are many reasons why people take out personal loans, and one of those reasons is investing. Using a personal loan for investing is not as strange as you might think. Businesses do this all the time. A company can finance its operations through equity (issuing shares) or debt. Analysts look at the ratio between the two as a relationship called “gearing”. This is the debt-to-equity ratio, which measures how leveraged the company is. While leverage can indicate risk, some amount of leverage can help grow a business, or your own investments, faster. Just be aware that some lenders will want to know the purpose of a personal loan and could disapprove when learning the purpose is investing.
Expected gain VS Interest Rate
You might be thinking now that taking out a loan for investing is a crazy idea, but it’s really not. The key is to ensure that your return on investment is greater than the interest you’re paying. If you can nail this, you will be profitable, which should be your only concern when taking out a personal loan for investing.
While the idea is controversial, there are a number of crypto enthusiasts who have openly admitted to taking out loans to purchase more cryptocurrency. For example, in December 2020, Peter McCormack, the What Bitcoin Did podcaster, said he had purchased 2.55 Bitcoin using a $46,250 loan with the expectation he would have to pay back more than $57,000 within six years. “In December 2026, if Bitcoin is at $22,669.35, I break even,” said McCormack.
Investing in Cryptocurrencies
As mentioned above, the idea of investing in crypto with personal loans is a controversial one. While the goal is to make a profit when the value of the cryptocurrency increases, there’s no way to guarantee that it will. It could just as easily fall in value, leading to a loss.
Consider this example:
In 2017 Bitcoin was on a massive rally that peaked just below $20,000 in December 2017. At that time, someone with good credit could have taken a personal loan with an interest rate of 7-8%. Suppose they took an 8% loan for $100,000 and purchased 5 BTC with a 5-year repayment term. The monthly payments for that crypto loan would be just over $2,000, and over 60 months, the loan would cost $121,658.37.
The last payment on the loan would be due in December 2022. If our fictional investors had gotten discouraged and sold during the crypto winter of 2018, they would have taken a massive loss as their 5 BTC would be worth less than $20,000. However, if they waited until 2021, the same 5 BTC could have been worth over $300,000, or a profit of nearly 180%. You can see just how Bitcoin performed in 2021 right here.
As you can see, it is possible to lose money when investing, which is why taking out a personal loan for investment purposes, whether it’s for cryptocurrency or some other asset, is generally considered risky. You’re taking a debt without knowing what profit to expect. And in the worst case, you could suffer a loss rather than again.
Laws and taxes
Currently, investing in crypto is legal in many jurisdictions, but there are some places where it is not legal. Therefore, always check to verify the legality of your crypto investment.
Another consideration when investing in crypto is the need to pay taxes on your gains. Again, this will depend on your jurisdiction. For example, countries like Puerto Rico and Portugal do not tax cryptocurrency gains. However, the U.S. and most European countries do, and you should be familiar with your country’s tax laws regarding cryptocurrencies.
This is particularly important if you’re taking out a personal loan to purchase cryptocurrency. If any gains are a taxable event, then those taxes also need to be factored into your potential profitability (or loss).
For example, a $1,000 gain on a $10,000 investment seems like a 10% gain. If your loan is at 8%, you have a profit. However, if there’s a 20% capital gains tax, then your $1,000 is only $800 after taxes, which means you are only breaking even on your loan.
Can a Crypto Loan Help You in Your Investing?
We’ve been discussing using traditional personal loans to purchase cryptocurrency. However, there’s also another type of lending you could take advantage of, commonly called crypto lending. This is where you pledge cryptocurrency you already own as collateral against a loan. If that sounds familiar, it’s because it is exactly like a secured loan.
Several specialized vendors make a crypto loan a possibility; however, just like using traditional lending for investments, there are risks to be aware of when you take out a crypto loan.
With the traditional secured loan, you risk losing your collateral if you default, which is also true of crypto loans. What’s more, if the value of the cryptocurrency you’re using as collateral falls, you may be required to add additional funds to maintain your collateral ratio. If you’re unable to do so, you risk losing the crypto you’ve put up as collateral.