Nearly everyone who buys their first home does so with a loan. Few pay cash. Not only does this allow people to buy a home sooner, it also enables them to accumulate some assets. Over time the debt will reduce and the house will increase in value, growing the owners’ equity.
Some people also borrow to buy investment properties. This works even better because they also receive the rental income to help pay the loan payments.
For the same reason people who buy farms and businesses often use debt. Even big companies employ borrowings in their businesses.
Borrowing to buy managed funds and shares also used to be common, before the global financial crisis of 2008-09. That caused heavy losses for those who sold. Those who held on long term recovered, but the event scared investors away from the strategy.
Buying share and fund investments with finance is still a practical strategy for those with reliable employment and good incomes. It is likely to become more popular with the new lower super contribution limits and frequent rule changes.
An investment loan can be taken against a home or other property, or as a margin loan using only the investments as security.
Loans secured by property are around 2 per cent per annum cheaper and the lender is not concerned about variations in the values of the investments.
Margin loans usually cost 6 to 7 per cent per annum and the lender tracks the investment values. A deposit of about 30 per cent is required and if the values fall sharply the borrower may have to pay in extra cash, a margin call.
Unlike buying an investment property, loans for funds and shares can be started with a small amount and increased over time if the investor is comfortable with progress.
For those who do not wish to borrow against their home or property margin loans can still be a very profitable strategy.
Margin loans can even be started with no initial lump sum, just a monthly investment contribution matched by a monthly borrowed amount. Over the long term this can build up to a large net equity position.
As with other investments the interest on loans taken to buy funds and shares is tax deductible. If the interest and expenses exceed the income from the investments the excess is deductible against other income such as salary, reducing the income tax payable.
People investing with borrowings need to take a long-term view, minimum five years, better 10 or more. This is because there will be fluctuations, good periods and bad. It is a higher risk strategy but can be very profitable. It also needs to be carefully planned, with a financial adviser.