Borrowing to Earn an Interest Spread? Think Twice

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Still awash with liquidity, many banks in Hong Kong now offer low-interest tax loan, P-loan, or even credit card loans to borrowers. Many such schemes bear an annual percentage rate (APR) as low as 2%-3%. That low-interest cost apparently attracts many local retail investors to borrow these loans, then invest the proceeds in higher-interest fixed deposit instruments or stable high-dividend paying stocks. However, borrow-to-invest schemes aren’t as good an idea as they might seem.

The interest arbitrage trade

At first glance, this kind of interest arbitrage trade seems to make sense. Under the current environment, high-credit-score retail investors are indeed able to borrow at around a 2% to 3% APR, and invest in local bond ETFs at around a 3.5% yield, or high-dividend-paying stocks at around 6% yield. The Hong Kong stock market offers plenty of the latter investments. Some time deposit promotions have also recently offered up to 3% interest rates to HKD depositors. These give interest spreads (investment yield minus borrowing interest rate) ranging from a few basis points to as high as around 4%.

Yet there are at least three critical shortcomings inside this interest arbitrage trade that should kill the deal.

Catch #1: Risk, risk, risk…

Traditionally, arbitrage produces riskless profit. The trade described above does not. Equities are the riskiest asset class among conventional investments, albeit with the highest average return. Investing entirely based on borrowed funds rather than savings further increases risk. At worst, you’ll lose all your savings in the latter case. But if your investments fail, loans could leave you with tons of debt to repay in years to come.

Catch #2: Cash flows

Even if you invest in super-safe and ultra-low-risk assets such as time deposits, you still need to mind the cash flows. Usually, these low-interest loans require even monthly repayments of principal, so you’ll have to redeem a portion of your investments regularly to meet monthly repayments. Time deposits, meanwhile, have fixed maturities and are not redeemable (at least, not without paying penalty) throughout the deposit period. For stocks, it is true that you can sell the stocks in even portions to meet the monthly repayment, but again, the short-term ups and downs in stock prices mean that you could be forced to sell at a loss.

Catch #3: Unnecessary interest cost

Perhaps you have a full-time job and can just use your monthly salary to repay the monthly installments. But then, wouldn’t that be kind of the same as saving up and investing your salary instead? That way, you’d save on interest costs and realize the full potential of your investment profit.

Unless you are certain of an investment upside that you lack capital to seize, and you know that opportunity will vanish quickly if you don’t ask, you’re better off staying away from borrowing personal loans to invest.


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