Taking a loan to buy something that is as volatile as crypto can really be a bad decision or maybe not? Who knows, you can make even make more ROI with it. But does that mean I’m suggesting you all take a loan and buy Bitcoin? A Big NO! So in this article, I’ve played around with some numbers to make the possibilities clearer and a bit more transparent for everyone who’s reading this. Personally, I’ve never taken a loan to buy Digital Currencies but I know some people who did and I’ll try to highlight their mistakes which you can avoid with a little research.
Before starting let’s talk a little bit about the options available to borrow money from the banks. As far as I’ve understood, there are broadly 2 types of loans that are available for people. One is a secured loan and the other one is unsecured. In the case of a secured loan, the borrower (which in this case is you) pledges some asset as a security to the bank to borrow money against it. This asset could be anything like Mutual Fund units, Shares, Gold, Property, Insurance papers, etc.
In the case of a secured loan, the interest rates are comparatively lower than unsecured loans. The reason is pretty obvious since the bank already has a plan B, in case the borrower defaults on his payments. They can sell your asset and get their money back which isn’t possible with Unsecured loans. Then what is an unsecured loan? It is a type of loan which is available to borrowers based on their credit history and income source without any collateral. These loans are generally given out at a higher rate of interest, since in Investing we all know, higher the risk, the higher returns.
Interest Rates & Risk
Now, if you’re planning to take out a personal loan for investing in crypto then you must be aware of the rate at which you’re borrowing money from the bank and the duration of the loan you’re planning to take. One thing to remember is, if you’re opting for a longer duration loan, the amount that you’ll have to pay back eventually will be higher compared to a loan of a shorter duration. That being said, this happens because of Compounding at play. Compounding works both on your assets and liabilities so planning about it in advance is crucial.
The second thing to keep in mind is the type of loan you’re planning to take out from the bank. If you’re opting for a lower rate of interest, the bank will ask for collateral against it. Government banks typically issue loans at a lower rate of interest at around 8.5% – 9% p.a, that being said, you’ll need to have a good credit rating and all the documentation need to show your ownership properly for the collateral. Don’t forget the risk in all these. If you default on your payments, the banks have every single power to sell off your collateral and collect the dues.
If you’re in doubt about whether to take a loan or not it is better to back off and save yourself.
Lastly, if you’re taking an unsecured loan from a private bank, you might end up paying upwards of 15% up to 25% p.a for your loan amount. If you don’t pay back this loan quick enough, things will compound faster than ever and you can end up paying more than double your borrowed sum in a matter of few years.
Why take a loan?
The reason for taking a loan could vary from person to person. Someone could be a trader who’s well aware of his personal liabilities and wants to hedge a position could borrow money from a bank. What I came to know from some of these people is that Debt isn’t taxable. If you earn 10 lakh rupees, you’ve to pay the government taxes based on your income source. On the contrary, if you borrow 10 lakh rupees, it is tax-free money. You’ll pay taxes only if you make profits using that money.
Other people can take debt just because they don’t want to gamble with their own money. If you’re too taking a loan, for this reason, I would highly suggest don’t take on additional liabilities unless you want to default on the loan and damage your Credit Rating.
People who are facing a financial crisis and are planning to use crypto as a mode of making a quick buck can also take a loan. These are the people who are at the most risk as per me. They can be convinced by agents to take a higher rate of interest loan and they will agree to all the terms just because they are too much optimistic about their trading skills which they acquired by watching some videos or by reading blogs. Eventually, these guys end up losing it all and end up in a never-ending debt cycle. This is the worst type & you shouldn’t be in this one.
What if you default on your loans?
If you’ve taken a secured loan, I don’t need to tell you what happens next. You’ve already guessed so far. If you’re the guy who has an unsecured loan, the banks will try their best to get their money along with interest out of your pocket. If you’re bankrupt and have no cash left, they might waive off a portion of the debt but you’ve to pay something to settle it. That has an adverse effect on your Credit Rating & it will make things difficult for you in the future to get a loan from any bank. That’s all that happens for sums less than 1-2 lakhs.
If you’ve defaulted on 15 lakh or 20 lakh, then you could face charges. I’m not sure what happens in court so I won’t comment on that.
Trade with Debt Money?
Let’s run down with some numbers. Let’s say you’ve borrowed 1 lakh rupees at 10% p.a for 1 year. I’ve used EMI Calculator site for this reference.
That brings us to a monthly EMI of Rs 8,792 or roughly 9% of the borrowed capital on a monthly basis. Overall you’ll pay around Rs 5500 as interest on your borrowed money. That’s easy if you have a separate fund to pay EMI’s on time and make profits using the capital.
Say you had invested Rs 1 lakh in Matic earlier this year. Or maybe you had diversified your investments and bought some Matic, Solana, Bitcoin, Ethereum, BNB, etc. All of them went up so far and in a bull market that should happen.
Now how much would you have till now from that Rs 1 lakh?
I’ve taken it more conservatively at 40% p.a. Every single coin mentioned above has given more than that. Assuming you switched your portfolio a number of times, I’ve taken 40%.
** This is an approximation and not a piece of financial advice. Before proceeding, you should really understand what you’re doing.
If you can’t manage debt and you’re in doubt whether to take a loan or not, please don’t take it. Unless you have a great understanding of the market and excellent patience this won’t work for you. Literally, you’ll need steel nerves to control emotions and make the most out of the market. I would say 80-90% of people will panic sell when they see their coins dipping. If you can’t control your emotions, please stay away.