There’s never been a cheaper time to borrow money, with some banks having dropped their mortgage interest rates below 4%. Rates this low make it very tempting to borrow more to buy a bigger house, add an extension, take an overseas trip, or trade in the car for a newer model.
While borrowing to spend has a detrimental effect on your financial future, borrowing to invest can be a good thing. If you can borrow money at 4% and invest in something that returns more than 4%, you will be financially better off. This is especially true if the interest is tax deductible against the income generated by the investment, which it generally is. Borrowing to invest can be risky because there are so many unknowns. It’s not worth borrowing to invest unless the expected investment returns are high, and the higher the expected returns, the more uncertainty.
Borrowing multiplies gains, but it also multiplies losses so it pays to do your homework. The most popular investment for borrowed funds has been property because it provides a steady income stream to cover interest costs and because property prices trend upwards over time with very little volatility. Borrowing to invest in a business is riskier as businesses, even established ones, can fail. Investing in shares with borrowed funds is another option, but the income from shares is generally not as high as income from property and may not fully cover borrowing costs. Share prices are volatile and being forced to sell at the wrong time can be disastrous. Investing in shares requires a long investment time frame and you need to be sure you have enough cash to get by without having to sell. It is also important to have a well-diversified portfolio. Borrow to invest in shares with great caution.
Liz Koh is an Authorised Financial Adviser. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847. For free eBooks, go to www.moneymax.co.nz and www.moneymaxcoach.com