Exploiting cheap loans?

JohnRo

Given the current economic climate is now as good a time as any to be using as much credit as possible to fund investments and pocket the difference?

I have cash available as collateral on the sort of loan I'm considering (assuming I can get approval) and any loans taken and invested would result in a worst case scenario where I lose whatever the investment does until it recovers.

I can't see deposit rates dropping much further and the interest rate upside is significant even if some way off.

Do you lot reckon loan rates have a way to fall yet?

I'm thinking £15K borrowed at 5.5% over 5 years invested in a HYB ought to be able to pay off that interest rate without any great difficulty and still have something to show for it at the end.

... or just another one of my many barking mad ideas?

grey_gym_sock

borrowing at 5.5% fixed over 5 years? ... no, that's far little margin for error ... too short-term for shares, even HYP ... and the margin (i.e. expected returns in excess of borrowing rate) is too low.

i'd estimate real total returns from shares at 4% p.a. (this is pessimistic, since history suggests more like 5% or 6%). i'd estimate that 5.5% is a real rate of 3.5% (i.e. that inflation will be 2% - this is my estimate of inflation only for the purposes of calculations where a high rate would be more optimistic). that gives a real expected return of 0.5%, or a total of c. 3% after 5 years. which is far too low, as short-term fluctuations in the equity market are likely to swamp that.

obviously you can use different assumptions. e.g. 6% real returns from HYP, and inflation at 4.5%, so a real return of 5% p.a. after 5 years, that's about 28% total return. that's still not enough! again, short-term fluctuations in markets could easily wipe that out.

if you can borrow money at 3.5% for 25 years, it might make sense, though.

JohnRo

Hmm, good points well made.

The thing I'm looking at is historic returns, which obviously can't and don't indicate or predict the future but do at the very least give a best guess guide to how the fund might performed over a period of time.

I mentioned a HYB (bond) as opposed to HYP

Taking the Kames High Yield bond, as an example, over a period of 5 years it has returned over 50% (with income reinvested) and that includes all of the financial meltdown, banking crisis, global slow down, Euro recession and subsequent stock market turbulence.

I'm not saying the future is looking rosy by any means, dark clouds are still on the horizon but I can't honestly see a repeat of the banking disaster and tsunami of doom and gloom we have been battered with, to such an extent as we saw over the last five years, repeated any time soon.

You'll have to forgive me but I also don't understand how inflation is a factor in these particular calculations, in terms of profit it is a simple, absolute, expense versus return percentage rate battle surely? Inflation is a subjective thing at the best of times and I'll be honest, the headline rates really don't mean a great deal to me personally and I suspect to many others either.

grey_gym_sock

ok, HYB, i missed that ...

inflation only came into it because it seems easier to estimate real returns for equities, and then you need to estimate inflation to see how that return compares with a fixed borrowing rate ... now, for bonds, it's probably easier to estimate nominal returns, and ignore inflation ...

if you match the term of your bonds with the term of the fixed-rate borrowing used to buy them, then the direction of interest rate movements doesn't matter, and you're only exposed to default risk ... fair point.

dunno if it's worth doing. it's not just whether it's worht the risk of default. presumably you have limited ability to borrow, so is this the best thing you can do with borrowings?

CLAPTON

JohnRo wrote: »

Hmm, good points well made.

The thing I'm looking at is historic returns, which obviously can't and don't indicate or predict the future but do at the very least give a best guess guide to how the fund might performed over a period of time.

I mentioned a HYB (bond) as opposed to HYP

Taking the Kames High Yield bond, as an example, over a period of 5 years it has returned over 50% (with income reinvested) and that includes all of the financial meltdown, banking crisis, global slow down, Euro recession and subsequent stock market turbulence.

I'm not saying the future is looking rosy by any means, dark clouds are still on the horizon but I can't honestly see a repeat of the banking disaster and tsunami of doom and gloom we have been battered with, to such an extent as we saw over the last five years, repeated any time soon.

You'll have to forgive me but I also don't understand how inflation is a factor in these particular calculations, in terms of profit it is a simple, absolute, expense versus return percentage rate battle surely? Inflation is a subjective thing at the best of times and I'll be honest, the headline rates really don't mean a great deal to me personally and I suspect to many others either.

I know nothing about that particular bond but do you know how bonds work?


e.g.
lets take a bond valued at £1,000 paying say 5% fixed pa for 10 years at a time when 5% is typical

now lets suppose that interest rates drop to 2.5%
then the value of the bond is likely to increase to 2,000 ish .


now what do you think will happen to the value of the bond if interest rates rise again?... go up or go down


what do you think will happen to interest rates in the future .. go up or go down?


think about it.

donkingkong

What makes you think you'll be able to profit from investing £15k of borrowed money over the next 5 years, when you've been unable to save £15k over the past 5 years?

Personally I think you're playing with fire and your odds of getting burnt are high.

JohnRo

grey_gym_sock wrote: »

dunno if it's worth doing. it's not just whether it's worht the risk of default. presumably you have limited ability to borrow, so is this the best thing you can do with borrowings?

The scenario I'm looking at is a 50K+ pot of cash to invest somehow, over a period of time yet to be determined.

I just considered the option, as stated if I can even get the loan.

The 15K loan is actually £14950 in this consideration as that's the upper limit for the lower 5.5% loan rate I saw, any more attracts a higher rate oddly.

Option one

just invest 15K of my money in said HYB and hope for a similar 50% over the next 5 years.

Option two

borrow 15K and invest that in said HYB and hope for 50% over 5 years while maintaining a 15K cash float covering the loan and earning market leading interest currently 3.2% but estimate 2% net AER net to be cautious.

By my reckoning that means the fund needs to return aggregate growth of just over 3.5% AER over the 5 years to break even and anything above that will see a profit.

puzzledinvestor

JohnRo wrote: »

Option two

borrow 15K and invest that in said HYB and hope for 50% over 5 years while maintaining a 15K cash float covering the loan and earning market leading interest currently 3.2% but estimate 2% net AER net to be cautious.

How is it profitable to borrow at 5.5% in order to have the same amount in an account earning 3.2%?

Not sure where the 3.5% figure comes from either. You surely need at least 5.5% annualized return (net of taxes!) in order to benefit from the loan, so the downside risk seems larger than the possible upside imho.

JohnRo

If I borrow to invest - that means I'm not touching my own money.

If I invest my own money the interest it would otherwise earn is lost at the point it is transferred to the investment.

Jegersmart

JohnRo wrote: »

If I borrow to invest - that means I'm not touching my own money.

If I invest my own money the interest it would otherwise earn is lost at the point it is transferred to the investment.

This is effectively leverage and when used in the right way can be useful. Risk management is key, and I think if you decide to go ahead with it then you need to really look at what you decide to invest in. I would go for something less risky than HYB's, I would probably go for an initial position in China equities (tracker or managed, your choice), some emerging Asia and something relating to natural resources. I say less risky, what I mean is that if a HYB has risen 50% in 5 years, it could easily do the reverse and if you look at China as an example it has taken a battering for the last 2+ years. I see less risk in China or Asian equities than I do in bonds that have been hugely inflated by money printing and low interest rates.

all very imho ofc.

J

CLAPTON

JohnRo wrote: »

If I borrow to invest - that means I'm not touching my own money.

If I invest my own money the interest it would otherwise earn is lost at the point it is transferred to the investment.

I would recommend you re-read my previous post.