How to Prepare for Investment If I Have a Loan?

It is tough to get in the flow of efficient financial management for those who only begin to deal with personal finance and investments. And very often, typical questions arise, like, how to save money properly, how to start building a safety cushion, or can I start investing money if I still have a loan? So today, I will try to answer the last question for you.

Before you start investing, you need to deal with loans. The average rate on microloans can reach up to 365% per annum, on consumer loans – up to 40%, on car loans – up to 13.6%, on mortgages – up to 9.2% per annum.

Now let’s compare these figures with fixed income indicators. On average, a balanced portfolio can give a novice investor from 8% to 15% return, but we must remember that the figures can be either higher or lower than forecast.

Since the investment yield is lower than the rates on microloans, consumer loans, and car loans, it is reasonable first to pay off current obligations to the bank and then think about investing.

What to Do If I Have a Mortgage

Against the background of other loans, mortgage debt is usually the largest; therefore, it seems to many that you need to pay it off first. But calculations show that just with a mortgage, you should not rush.

Consider two approaches to a mortgage loan:

• Early repayment. As a rule, the main maintenance of a real estate loan falls on the first 3-5 years. Suppose it was impossible to settle accounts with the bank during the specified period. In that case, closing obligations beyond this period are not advisable from the point of view of financial gain.
• Refinancing. The purpose of refinancing is to lower the current mortgage rate, reduce the monthly payment, and shorten the obligation term. Refinancing is beneficial if the rate on a new loan is less than the existing one by 1.5–2%. Refinancing is not profitable if the borrower has already repaid more than 50% of the loan. The reason for this is the annuity payment system when interest is paid first and only then the loan body.

Thus, if the mortgage rate is less than the investment yield and monthly payments are not sensitive to the family budget, then part of the salary can be invested in securities.

Please note that it is better to postpone investment if:

• More than half of the family’s income goes to paying off the mortgage. In this case, it is better to throw all your efforts into closing part of the debt obligations, reduce the credit burden to 30%, and only then start investing;
• No financial cushion. The presence of a mortgage and the absence of a fund for force majeure situations can create a severe deficit in the family budget. It must be remembered that investments are a risk, so it is better to have savings in the amount of 3-6 monthly salaries to cope with unforeseen situations.

How to Prepare Yourself for Investing

If the loans are fully or partially closed and a decision is made to invest, then before opening a brokerage account, you need to:

• Structuring income and expenses. This helps to understand where the money “leaks through your fingers”. If possible, reduce expenditure items and direct the saved money to investments.
• Improve financial literacy. It is not necessary to get an economic education, and it is enough to take courses from professionals, read books, learn what taxes an investor pays, and figure out which instruments are riskier and which ones a beginner should start with.
• Remember financial discipline. It is handy to keep this in mind for those who allowed delays in paying loans and took loans without balancing their financial capabilities.
• Learn about pyramid schemes. If someone promises super income, they are most likely scammers or a high-risk financial instrument.
• Avoid new loans. Under no circumstances should you invest in debt. Even if the bank promises a loan at an interest rate lower than the investment yield, this is the wrong way. You can and should invest only your free funds.
• Prepare for responsible investing. At some point, all beginners want to capitalize on the rise and fall of securities. But these are speculations that have nothing to do with investing.

If all the points are completed, you can begin to master a new topic for yourself – investments.