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Borrowing to invest

Know the risks before you get an investment loan

Page reading time: 4 minutes

Borrowing to invest, also known as gearing or leverage, is a risky business. While you get bigger returns when markets go up, it leads to larger losses when markets fall. You still have to repay the investment loan and interest, even if your investment falls in value.

Borrowing to invest is a high-risk strategy for experienced investors. If you're not sure if it's right for you, speak to a financial adviser.

How borrowing to invest works

Borrowing to invest is a medium to long term strategy (at least five to ten years). It's typically done through margin loans for shares or investment property loans. The investment is usually the security for the loan.

Margin loans

A margin loan lets you borrow money to invest in shares, exchange-traded-funds (ETFs) and managed funds.

Margin lenders require you to keep the loan to value ratio (LVR) below an agreed level, usually 70%.

Loan to value ratio = value of your loan / value of your investments

The LVR goes up if your investments fall in value or if your loan gets bigger. If your LVR goes above the agreed level, you'll get a margin call. You'll generally have 24 hours to lower the LVR back to the agreed level.

To lower your LVR you can:

If you can't lower your LVR, your margin lender will sell some of your investments to lower your LVR.

Margin loans are a high risk investment. You can lose a lot more than you invest if things go sour. If you don't fully understand how margin loans work and the risks involved, don't take one out.

Investment property loans

Investment property loans can be used to invest in land, houses, apartments or commercial property. You earn income through rent, but you have to pay interest and the costs to own the property. These can include council rates, insurance and repairs.

See property investment for more information.

Borrowing to invest is high risk

Borrowing to invest gives you access to more money to invest. This can help increase your returns or allow you to buy bigger investments, such as property. There may also be tax benefits if you're on a high marginal tax rate, such as tax deductions on interest payments.

But, the more you borrow the more you can lose. The major risks of borrowing to invest are:

Borrowing to invest only makes sense if the return (after tax) is greater than all the costs of the investment and the loan. If not, you're taking on a lot of risk for a low or negative return.

Some lenders let you borrow to invest and use your home as security. Do not do this. If the investment turns bad and you can't keep up with repayments you could lose your home.

Managing the risk of an investment loan

If you borrow to invest, follow our tips to get the right investment loan and protect yourself from large losses.

Shop around for the best investment loan

Don't just look into the loan your lender or trading platform offers. By shopping around, you could save a lot in interest and fees or find a loan with better features.

Don't get the maximum loan amount

Borrow less than the maximum amount the lender offers. The more you borrow, the bigger your interest repayments and potential losses.

Pay the interest

Making interest repayments will prevent your loan and interest payments getting bigger each month.

Have cash set aside

Have an emergency fund or cash you can quickly access. You don't want to have to sell your investments if you need cash quickly.

Diversify your investments

Diversification will help to protect you if a single company or investment falls in value.

Gearing and tax

Borrowing to invest is also known as 'gearing'. Before you borrow to invest, check:

See investing and tax for more information about positive and negative gearing.

Man standing with his hands in his pockets.

Kyle gets a margin call

Kyle has $10,000 invested in shares. He decides to borrow $15,000 to invest in more shares through a margin loan. The total value of his shares is now $25,000.

Kyle's LVR is 60% ($15,000 / $25,000). The maximum LVR his margin lender allows is 70%.

Kyle has invested in five mining companies. He's taking on a lot of risk as he's not diversified. After a fall in the price of commodities, Kyle's shares fell by $5,000. The total value of his investments is now $20,000. The value of his investment loan is still $15,000.

Kyle received a margin call from his lender as his LVR had increased to 75% ($15,000 / $20,000). He had 24 hours to lower his LVR.

Kyle used $2,000 of his savings to reduce his loan balance to $13,000. This lowered his LVR to 65% ($13,000 / $20,000).

Kyle has money in a savings account ready in case he gets another margin call.