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What Are The Benefits of Borrowing to Invest?

  1. Tax Deductibility
    If you borrow to invest in assets, the interest payable on those loans is generally tax deductible as long as they are used to buy an income-producing asset. This can help you reduce the tax you pay on your salary while freeing up your own cash to be used for non-tax-deductible expenses such as the family home or other lifestyle expenses.
  2. Leveraging to Increase Capital Gains 
    Borrowing to invest will allow you to purchase a bigger size asset on which you will create more wealth should that asset rise in value compared to if you had not borrowed any money.  For example, if someone invests $50,000 and they earn 6% growth they will make $3,000.  If, instead, they use that $50,000 for a deposit, borrow $450,000 and buy a $500,000 property that goes up in value 6%, then they have created $30,000 of wealth.

What are the types of investment borrowing?

Direct Property

When purchasing a residential property, a lender will loan up to 95% of the property’s value. In the case of commercial property, it’s 70%. Interest rates are relatively low compared to other forms of investment borrowing as lenders consider ‘bricks and mortar’ very safe.

Margin Lending For Shares

Margin lenders will provide up to 80% of the value of the purchase price for a share or managed fund portfolio. The lender tracks the portfolio daily and if the value drops too close to the value of the loan, the lender will issue a ‘margin call’requiring the investor to inject more of their own funds or sell down part of the portfolio. Interest rates are higher than for home loans as shares are considered more volatile than property.

Warrants

Warrants are a type of investment lending structure that usually mean your downside risk is limited to the ‘deposit’ that you have personally put into the investment.In other words, you are not liable for any losses should the asset be sold at some point for a lower value than the loan attached to it.

For example, you borrow $70 and combine this with $30 of your own money which you invest in a stock called Argos Resources through a warrant structure.  At the end of the investment term the stock is only worth $60 and is sold.  Ordinarily you might lose your initial money and owe the lender $10. However, with a Warrant you are able to walk away having lost the $30 and you are not required to cover the lender’s losses.

Structured Lending

This is when 100% of the investment amount is lent to the investor and, normally, 100% of the loan amount is protected over the term of the investment. For example, if a $50,000 loan was taken out over a term of 5 years, the worst-case scenario for the investor is that at the end of the 5 years, the investment would still be worth $50,000. This means that if the market drops, the investor is guaranteed not to be out of pocket.

Variable or Fixed Interest Rate

A variable rate provides the ultimate flexibility but, obviously, you need to be comfortable with rates rising or falling. Fixed rates provide certainty as to what the interest rate and your monthly repayments will be. Fixed rates can range from one to five years.

Whatever you do, do not go with fixed rate simply because you think you can pick the bottom of a fixed rate cycle. And if you do fix, make sure you have no plans to sell your property within the fixed rate period because if you do you may incur substantial break costs.

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