- Date : 28/07/2021
- Read: 12 mins
Know the pros and cons of taking a personal loan to invest
Growing up, many of us have had the following line from William Shakespeare’s Hamlet drilled into us as a life lesson: “Neither a borrower nor a lender be.” We were told not to lend or borrow books – or money.
However, as the modern banking system has taught us, Shakespeare was only half right in his advice: not all loans are necessarily a bad thing; they have their upside too. This is typified by personal loans, which have their pros and cons.
A personal loan can be used for a variety of purposes, including making investments. In this article, we shall discuss its various facets, its pluses and minuses, and see what experts have to say about using it for investment purposes.
What is a personal loan?
Personal loans are loans that can be used for any number of personal expenses. Unlike education loans, car loans, or home loans, they are not earmarked for funding specific expenses. Typically, personal loans are more expensive than specific-purpose loans.
The borrower may use a personal loan to:
- Consolidate debt for making repayments easier;
- Meet credit card dues;
- Pay for home renovations;
- Fund a dream wedding;
- Meet unexpected medical expenses;
- Pay for unplanned and unavoidable costs like funeral expenses – for instance, a shradh ceremony for a departed one is something no one saves for, but is generally considered a must by many;
- Take a vacation;
- Invest in stocks;
- Tackle a personal emergency (such as paying off a loved one’s debts);
- Make a wish possible, like throwing a lavish wedding anniversary party, or acquiring something that catches one’s fancy.
What are the key features of personal loans?
Personal loans are offered by banks, NBFCs, credit unions, or online lenders, both as secured and unsecured loans. The first involves pledging some sort of collateral, which can be cash assets such as a certificate of deposit (CD), or a physical asset such as your car. An unsecured personal loan requires no collateral.
The collateral reduces the risk quotient, hence secured loans are considered safer, and carry relatively lower interest rates. Unsecured loans attract higher rates as there is no collateral to be impounded in case of a repayment default.
Personal loans have to be repaid by a predetermined date and can vary greatly when it comes to interest rates, fees, loan amounts, and repayment terms. What’s more, banking services and products attract a GST of 18%; this too must be considered when taking a personal loan.
How to get personal loan
You can get personal loans up to Rs 50 lakh for a tenure of seven years, depending on the level of your eligibility; processing fees charges by lenders may range from zero up to 3%.
Lenders may or may not insist on collateral, but they will surely ask for the following:
- Identity proof (passport, Aadhar card, driving license or PAN card)
- Proof that you have a stable income (salary slips for two years if you are employed, or audited financial statements for two years if you are self-employed);
- Proof you have a permanent residence (passport or utility bills)
You will also have to meet the standard eligibility criteria, these being:
- At least 21 years of age, and not older than 60 years
- Have a CIBIL score of 750 and above (CIBIL score ranges from 300 to 900; chances of approval rises as your score nears 900)
- Have a steady monthly income of at least Rs 15,000
The loan processing officer will vet your loan application on the basis of the documentary proofs you submit. The loan amount, which will be deposited in your bank account, will have to be repaid in instalments over the loan tenure.
Interest rates offered by banks
Banks offer personal loans of up to Rs 40 lakh to salaried people at interest rates ranging from 10.4% to 25%, and repayment tenures between 12 months to 60 months.
The rates offered by various banks and NBFCs on different amounts are given below:
|Bank||Interest rates (p.a.)||Loan amount|
|HDFC Bank||10.75% to 21.30%||Rs 50,000 to Rs 15 lakh|
|ICICI Bank||11.25% onwards||Up to Rs 20 lakh|
|Axis Bank||12% to 24%||Rs 50,000 to Rs 15 lakh|
|State Bank of India||10.50% onwards||Up to Rs 20 lakh|
|Canara Bank||12.55% to 14.60%||Lender’s discretion|
|Punjab National Bank||11.5% to 14.5%||Up to Rs 4 lakh|
|Bajaj Finserv||12.99% onwards||Up to Rs 25 lakh|
|Yes Bank||10.99% onwards||Up to Rs 40 lakh|
|Union Bank of India||12.10% onwards||Up to Rs 10 lakh|
|DCB Bank||13% to 25%||Lender’s discretion|
What are the pros and cons of personal loans?
As you can guess from the reasons cited above, a personal loan can be a godsend during financial emergencies. However, like everything else, this too has its plus and minuses. Let’s start by listing the benefits:
- It is multipurpose: Most other loan products have specific end-uses, such as buying a house or a car, but a personal loan can be spent on anything. This allows borrowers to spend something important to them, say, financing a pilgrimage for one’s parents. However, this also has a downside, which will be discussed later.
- Satisfactory loan amount: If the borrower meets the requisite conditions, they will receive loan amount asked for, irrespective of the requirement; there is no fixed limit on the loan amount. However, the actual amount will vary from case to case.
- Quick processing: Banks and NBFCs usually fast-track the loan approval process, taking a day at most, provided the paperwork is in order. This is handy during emergencies.
- Collateral optional: Eligible individuals can be sanctioned the loan requested without having to furnish any security against it.
- Simple documentation: Lenders generally ask for minimal documentation, such as basic proof of identity, address, and income in most cases. This speeds up the loan processing.
- Flexible term: Borrowers can choose a repayment term, typically ranging between one and five years, as per their convenience. This flexibility helps spread the interest and reduces the repayment burden.
But along with these benefits, there are certain problems associated a personal loan. These are:
- High interest rates: As explained earlier, interest rates for personal loans – which are unsecured – are higher than that quoted for secured loans, and typically range between 12% and 25%. This can make repayment harder for many borrowers.
- Significant processing fee: Similarly, processing charges are typically higher than that levied for secured loans. As a result, the amount a borrower gets is lower than that requested.
- Strict eligibility criteria: Also problematic are the stiff eligibility criteria for personal loans. The applicant’s income and credit score come under scrutiny.
- Repayment rigidity: Lenders do not permit changes once the repayment period is chosen, which rules out prepayment or part-prepayment. EMI defaults can attract legal action.
- It is tempting: Last but not the least, it can be very tempting to take a personal loan for spending on something totally unnecessary, and thereby end up in debt.
Personal loan for investments: Does it make sense?
Sometimes, people take out a personal loan to make an investment in the stock market; this is known as ‘gearing’ or ‘leveraging’. But is it a good idea to take a personal loan to invest in shares? There are two schools of thought on this – for and against. We will look at both, starting with those for it.
Arguments in favour of using personal loans for investing
The broad argument for this practice is that returns from investments in stocks cover the costs of the loan and leave a tidy profit. NBFCs push personal loans for investment purposes, saying it allows one to have more capital to invest in a market that has the potential to generate a hefty return.
For instance, Fullerton India says personal loans open up a “greater investment value spectrum” for the investor simply by virtue of having access to more funds to invest. Bajaj Finserv also talks of “greater investment value spectrum”, which “encourages the chances of making a hefty profit”.
NBFCs also state that income from stock market investments acts as a “cushion for ancillary expenditure” that comes with a personal loan – high interest rates and monthly loan servicing expenses. But in case the expenses outweigh your returns from investments, argues Bajaj Finserv, there is a bright side to that as well: “your taxable income reduces”.
Fullerton, however, has a word of caution. Using a personal loan for investment “only” made sense if the investor is looking at long-term returns while having access to a stable income source. This, it says, enables one to take care of monthly EMIs “without worrying too much about short-term performance”.
Arguments against using personal loans for investing
Interestingly, Fullerton India is against using personal loans for intraday trading, saying market volatility makes it a bad idea. “If your investments don’t pan out, you will still be left with EMIs to pay,” it warns.
This is exactly what opponents to the practice say, echoing Fullerton’s caution in short-term punts, and pointing out that investments need time to gain momentum and appreciate in value.
According to Aaneev Wealth Managing Partner Amit Kachroo, it doesn’t make sense to borrow money at 14% interest and expect higher returns in a short span of time. “It is exceedingly risky to invest in stocks, and that too for the short term,” Kachroo was quoted by Moneycontrol as saying.
Abchlor Investment Managing Director Abhinav Angirish believes the odds will never be in favour of such investors. “There is more than a 50% chance that the person borrowing will end up with a negative portfolio, if he invests for short-term gain with borrowed money,” he told the same publication.
But do these arguments mean investing loan amounts in the equity market will bring profits in the long term? No, says Orowealth CBO and COO Vijay Kuppa. “Even in the longer term, unless one is very lucky, they will not make any net returns even after investing well,” he told Moneycontrol.
Value Research CEO Dhirendra Kumar echoes the sentiment, calling the practice “very undesirable and dangerous”. His reasoning is straightforward: if the investor succeeds, they will become a speculator and run the risk of losing it all in the long run. But if the investment fails, the person will end up paying interest on the loan on top of the capital market loss.
What about investing in mutual funds and cryptocurrency?
Apart from shares, you may also consider equity mutual funds, which may bring you returns of 10-12%, if we are to go by their long-term historical returns. But if the interest you pay on your personal loan is more than this, it doesn’t make financial sense, does it?
With the Supreme Court lifting the RBI’s ban on cryptocurrency transactions on March 4, another option has opened up for you. But do remember, there is no government policy on cryptos, which have no underlying assets. This also means crypto transactions are unregulated, and price discovery remains iffy.
This apart, Bitcoins are classified as assets under income-tax laws, which means if you sell your Bitcoins before three years, provisions of short-term gains will come into play, and any income will be taxed as per your tax slab; if you sell after three years, you are liable to pay a 20% long-term capital gains tax with indexation benefits.
Opponents trot out a list of risks that one takes when thinking of investing loan amounts in the equity market:
- First, there is the uncertainty in making profits in IPOs, stocks, and derivatives. Returns can be negative, eroding the value of the investment;
- Second, the interest rate on the loan taken can increase, which can make the investment unprofitable;
- Third, the stock invested in may Risks to investing with a personal loanunderperform even when the market is upbeat, primarily due to bad management or inherent flaws in that company’s business model;
- Finally, the loan tenure may not be in sync with the time needed for desired returns. If the market crashes, an investor may not have sufficient time to recover the losses.
If you’re thinking of taking a personal loan that you can invest in the capital market, first understand what a personal loan is, weighing its advantages against its disadvantages. If you then think a personal loan is the way you want to access investible capital, then weigh the risks listed above. Finally, ask yourself the following questions:
- Does the investment guarantee results?
- Can the returns cover an interest rate of around 14% and processing costs of the loan application?
- How will the loan be repaid if the returns are not as expected?
- Is the promise of the return worth the risk?
- If you still want to go ahead, do remember that losses can mount quickly and you can be left with a huge hole in your pocket in addition to the loan burden.