Investing is a powerful way to increase your net worth and generate passive income. One question that some investors wrestle with is whether using a high-interest personal loan to fund an investment opportunity is a good idea.

While personal loans can provide quick access to capital, these personal loans generally come with a very high interest rate. In particular, unsecured personal loans will carry some of the highest interest rates in the debt markets.

Understanding High-Interest Unsecured Personal Loans

Unsecured personal loans provide many individuals with quick access to cash. The interest rates on unsecured personal loans can range from 10% to 36%, depending on your credit score, income, and other outstanding debt obligations.

Unlike secured loans, these loans don’t require you to post collateral before getting the cash. Because the loans have no collateral, they are some of the riskiest loans a lender can make. Once you receive your funds, you can use the proceeds for any purpose. Most individuals use the proceeds to consolidate debts or pay for unforeseen expenses, such as medical bills or home repairs.

Due to the high interest rates, individuals should carefully assess whether an unsecured personal loan is a wise financial decision.

Why Some People Consider Borrowing for Investments

There are several reasons why someone might consider taking out a personal loan to fund an investment, particularly if they feel an opportunity is too good to pass up. If you feel an investment opportunity has the potential for exponential returns, then the high interest rates attached to personal loans may be worth the cost.

For example, assume you are approached with an investment opportunity where the manager expects the investment to triple within three years. The minimum investment is $20,000. You receive an offer for a personal loan of $20,000 with an interest rate of 21%. Even though the interest rate is high, if you’re confident the $20,000 will become $60,000 in three years, then the 21% interest expense might be worth the cost.

U.S. Tax Implications for Personal Loan

Interest expense for U.S. tax purposes falls into one of three categories:

  • Personal Interest Expense
  • Investment Interest Expense
  • Business Interest Expense

In general, personal interest expense on personal loans and credit cards is nondeductible for U.S. taxpayers. The personal interest is not deductible because it is attributed to debts incurred for personal uses and not for business or investment purposes.

Investment interest expense is tax-deductible to the extent a taxpayer has investment income. If you borrow money using a personal loan to fund an investment opportunity, the interest expense may be tax deductible as itemized deductions. The investment interest expense is reported on Form 4952 (Investment Interest Expense Deduction) and Schedule A (Itemized Deductions).

What are the Risks of Using a High-Interest Loan for Investing

The biggest downside to using a high-interest personal loan for investment is the cost of the loan itself. With interest rates ranging anywhere from 10% to 36%, your investment must generate significantly high returns just to cover the interest expense.

For example, the average return on investment (ROI) for the S&P 500 is approximately 10% annually. If you borrow funds using a personal loan with a 21% interest rate and use the proceeds to purchase an S&P 500 index fund, the yearly ROI will be far less than the interest expense. If you invest the funds this way, it would not be a wise financial decision.

In order to generate an ROI exceeding the 21% yearly interest cost, you’ll need to find investments with substantial upside potential. You cannot simply purchase index funds, ETFs, bonds, or other low-risk low-yield investments.

Secured Personal Loans

Some investors have access to secured personal loans to fund new investments. For example, an individual with a substantial stock & bond portfolio could use a Securities Backed Line of Credit (SBLOC) to fund new investment opportunities.

Because the SBLOC uses collateral and is generally available to highly credit-worthy individuals, the interest rates on SBLOCs are far lower than those on unsecured personal loans.

Conclusion on Personal Loan Funded Investments

Using a high-interest personal loan for an investment opportunity may seem tempting, but it carries some risks. The high interest rates attached to personal loans may make the investment unprofitable unless the returns are substantial. Think carefully about both the investment opportunity and how you plan to finance the investment before making any decisions.