Posted by Ryan on February 4th, 2008 in Credit and Debt

On Saturday I was a guest author at Gather Little by Little where I wrote, Should I Get a Loan to Invest, which discussed why using other people’s money can create riches. I stressed, thought, that this is a strategy that should only be considered by the experienced, well financed investors.

If you think you have a sure bet that can make you very wealthy, here are a few ways to get a loan to use as an investment.

Buying on Margin

Probably the most popular investment loan strategy, most brokerage firms will allow you to open a margin account. Since margin balances are high interest rate loans, they are generally used for short-term trading. This is traditionally how trading is done on the foreign exchange (FOREX) market.

By buying on margin, you are essentially borrowing money from your brokerage to purchase stock, which allows you to borrow up to 50% of the purchase price of the stock. So, if you want to buy $10,000 worth of stock, you only need $5,000 of your own money.

Should the stock fall though, your risk experiencing a “margin call,” in which case you are forced to either sell your position at the loss or add more cash to the account in order to remain at the 50% maintenance margin level. Since your brokerage can liquidate your positions when you are over your maintenance margin level, you are susceptible to quick losses in a volatile market.

Home Equity Loan

A home equity loan allows you to borrow up to 125% of the appraised value of your home (minus the balance of your existing mortgage). So, if your home is worth $200,000 and you owe $100,000 on your mortgage, you can qualify for a $125,000 loan. These can be attractive, low-interest loans.

The risk is that your home is the collateral supporting the loan. If your investment takes a dive and you are unable to repay the loan, you lose your home.

Using Your Credit Card

Most credit cards hit their customers hard with rates on cash advances; generally in the 20% range. Every once in a while you can find an offer for attractive 3-4% cash advance rates, but this is rare.

If you stumble upon an offer like this, you may want to consider the terms, such as how long the offer is good for. Considering the stock market historically returns 10% a year, this could be a viable option to infuse money into an index fund. This return is assuming a 10-year investment horizon. Year-over-year the market returns are far more volatile, with some down year, some up years, and some flat. Over time though, the stock market evens out to roughly a 10 percent annual return.

Millionaire Money Habit: Taking out a loan in order to invest is generally not a recommended strategy. Yes, you can leverage other people’s money in order to make money, but please consider the risks and the worst case scenario. Always consult with a certified financial planner before considering such a risky venture. -RT

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