Returns on Investment vs. Loans

[fetish]

Hello,
This is more of a generic question about when to take loans and when to invest money, but I'll give you my scenario to simplify:

I recently financed (at about 6%) my "dream car" (it was a 2005 model used car for 8k). I general I would have only payed cash, but I realized that the returns on my money (about 15%, mostly via LendingClub) are much higher than the rate on the loans that were available to me. In these situations, is it better to take the loan than to pay cash? I'm losing that 6% on that 8k every year, but I'm picking up 15% on the exact same dollars at the same time.

My question ultimately is, when you can take out a loan at a lower rate than you can get returns on a separate investment, is that a good move?

Thanks!

[js625]

I am a long term investor in lending club, and I honestly doubt you will be able to sustain those 15% gains.  Those are very risky loan grades you are invested in, and I hope you are spread out amongst many different notes.  This is also similar thinking that the banks used leading up to the financial crash (assuming high risk mortgages would pay out forever without default, and then leveraging against it).  No one knows how Lending Club will perform if there is a significant downturn in the economy since the process is so new.  My guess is you would see many of your notes start to default and you're returns would quickly erode.

Just be careful, that is not a sound strategy to assume those gains will continue if you are going to leverage existing money against it with other loans. 

[TheMoneyBadger]

Mathematically, if you make a higher rate or return on the investment then you paid on the loan, you'll come out ahead.  That said, the 6% you're paying is a fixed rate and the return you're seeing on your investments is not.  You'll experience volatility and you're unlikely to guarantee a 15% rate of return over longer periods of time.  The other thing I'd consider in this situation is cash flow.  You'll have a monthly bill you need to pay no matter how your investments do.  Do you have the available cash flow, even if the market crashes and you don't want to cash in investments, to keep paying that bill?

[fetish]

@js625 so, I've got about 1,600 loans, mostly of D/E grade. Over about 18 months in, i've had a grand total of 5 default to the tune of $122. I go almost exclusively for credit-card refi loans because those consumers are actually reducing their monthly debt service. I feel comfortable in this for the next 5 years or so.

@Cathy - that's genius. Are there any strings to watch out for? A blog article that's more in-depth? It sounds like something I'll be doing that in the future - my current loan has a no-prepayment penalty, so it's not too late (I bought the car ~2 weeks ago). In this case, I bought the car to move cross-country. I've been carless almost my entire life (except my sophomore year of college, when I commuted - I'm 34 now), but i figured it would have cost $2500 for a moving van/uhaul, and i'd still need a vehicle for house-hunting, buying furniture, etc. I plan on selling the car once i'm settled in. If I can sell it more about 75% of the initial value (it already had 107k miles on, at 112k it should hold value pretty well) then I won't be behind compared to using a UHaul.

@themoneybadger yes - even without any investments, I could have fit the car and insurance payment in my existing budget, which is based solely around the paycheck. And my LC money does give me a cashflow of about $1500/mo, although at present i reinvest most of it.

[This_Is_My_Username]

My question ultimately is, when you can take out a loan at a lower rate than you can get returns on a separate investment, is that a good move?

yes, however:


1. There needs to be an adequately sized gap between the two rates.  6% guaranteed on a loan repayment is usually better than a volatile 7% in shares. 

2. If the loan has any fees, (and most do), the actual interest rate is higher than 6%, due to the fees. 

3. There may be tax consequences in your country, based on the purpose of the loan.

4. I am skeptical that you are really getting 15% on LendingClub.  most other people report less.

[js625]

you're still only halfway through, just trust me your returns will go down it's just the nature of the loans...I hope they don't though! 

[Raay]

Before you use your overnight margin loan, ponder a bit why Interactive Brokers is ready to forego that great 15% investment of yours and only get a 1.5% from you in fees instead.