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Leveraging, or borrowing to invest, is an aggressive investment strategy. It has benefits and risks that need to be considered before embarking on this type of strategy.

The Benefits

  • It enables you to have more money to invest, potentially combining your money and the borrowed money.
  • It enables you to invest in higher value assets, something that you couldn’t do without it. For example, using a $200,000 deposit (savings) and borrowing $450,000. This enables you to purchase a something for $650,000 (excluding legal and stamp duty etc.).
  • Taxation benefits – depreciation and negative gearing.

You can achieve a higher return. For example:

NO BORROWED MONIES BORROWED MONIES
Invested Capital $200,000 $200,000
Investment Loan $0 $450,000
Total Investment $200,000 $650,000
Rate of Return (%) 10% 10%
Return ($) (Gross) $20,000 $65,000
Difference + $45,000
Value of Capital $220,000 $265,000

*This is an example only does not include any potential tax implications.

The risks

This type of investment strategy is not for everyone.  Borrowing to invest means the risk is higher as you have to repay the loan regardless of how the investment is performing.  There are several areas to consider with this strategy:

  • Investment income risk– lower than expected income. For example, you may have occupancy issues in your rental or a company doesn’t pay out a dividend this year. Do you have funds set aside to cover this?
  • Interest rate risk– Rates could rise. If they rose by 1% or 3%, could you still meet the repayments?
  • Income risk– If your personal income ceases or decreases due to sickness, injury or redundancy how would you cover the loan repayments?
  • Capital risk– The value of the investment may decrease and the proceeds from the sale may not cover the remaining loan balance. Can you afford to cover this extra cost?

Using the same example from before:

NO BORROWED MONIES BORROWED MONIES
Invested Capital $200,000 $200,000
Investment Loan $0 $450,000
Total Investment $200,000 $650,000
Rate of Return (%) -10% -10%
Return ($) (Gross) -$20,000 -$65,000
Difference – $45,000
Value of Capital $180,000 $135,000

*This is an example only does not include any potential tax implications).

In a worst case scenario, if you use your residential property as security, you could lose your home.

If you want further information on borrowing to invest go to the Federal Government Money Smart website https://www.moneysmart.gov.au/investing/borrowing-to-invest. Also go to Investment Options/Choices.

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