Borrowing money for any type of investment can be risky business, especially if your potential investment idea has an unproven track record.
Building long-term wealth is an essential part of any financial plan, and with current interest rates at near 40 year lows, borrowing money to invest may be a wise choice, if you are aware of the risks involved and any consequences that you may face should your investment go south.
The Basics of Borrowing Money for Investment Purposes
The first thing that potential borrowers must realize is that every loss or gain associated with borrowed funds is magnified, especially if the borrowed funds make up the majority of your investments.
If your original investment equity was $10,000 and you borrowed an additional $40,000 for a total of $50,000 in an investment fund, the gains or losses will be based on your original equity. Instead of a 10 percent gain or loss, $5,000 would be considered a 50 percent gain or loss on your original funds.
Margin stock accounts are the most common borrowing-to-invest opportunities. Margin stock accounts involve purchasing stocks with a combination of your own capital and borrowed funds from your investment firm. These accounts are great for individuals looking to increase their long-term financial portfolio because they are allowed to purchase a large amount of stocks with smaller amounts of money.
If you plan to open a margin stock account, you must be aware of what the market is doing at all times. Brokerage firms are allowed to sell off your securities if the market takes a turn for the worse.
What You Need to Open a Margin Stock Account
Opening a margin stock account may be difficult for some potential borrowers.
First, your broker will likely require you to front additional money when you open the account or will be asked to cover any financial losses when the market declines. Because the brokerage firm will be loaning you money to use for your investment, they will likely ask to do a credit check before you open your account. A poor credit history may be cause for your application to be declined.
Once you have been approved for a new margin stock account, read the agreement very carefully. Understand how much you can borrow, the minimum margin amounts and how much capital you need to maintain the account.