Passive Borrowing Strategies: Are you Exposed to Rollover Risk?

By / / Debt
passive borrowing strategies - borrowing money

The aim of passive borrowing strategies is to borrow funds with the least amount of effort. Unfortunately, the least amount of effort usually goes hand in hand with the least amount of due diligence. This often results in expensive and risky debt.

In this article
  1. What are Passive Borrowing Strategies?
  2. Examples of Passive Borrowing Strategies
  3. How to Minimize Passive Borrowing Strategies
  4. Passive Borrowing vs Passive Investing
  5. Wrapping Up

What are Passive Borrowing Strategies?

Are you able to answer the following question taken from the CFA mock exam (Certified Financial Advisor exam)?

Passive borrowing strategies most likely:

  • a) diversify the types of borrowing.
  • b) expose borrowers to rollover risk.
  • c) seek to increase the number of lenders.

The correct answer is b):

  • Passive borrowing strategies most likely expose you to rollover risk.

Examples of Passive Borrowing Strategies

HELOC – Home Equity Line of Credit

A common example of passive borrowing strategies is taking out a Home Equity Line of Credit (HELOC). When you take out a HELOC against your home, the bank lends you money using your home as collateral. The rate offered by the bank for the first few years and for the initial amount borrowed is usually comparable to other low-interest loans. But, when the honeymoon period is up, or if you borrow more funds, the rate can automatically rollover and increase by 2-3 percentage points. Over time, you end up paying a larger portion of your income to the bank in interest instead of paying down the capital.

Personal Loan

Another example of a passive borrowing strategy is taking out a personal loan from an online lender to consolidate your high-interest debts. The initial rate will be competitive, but after a term of 1-3 years, the loan will automatically rollover to an increased rate which is 2-3 percentage points higher. While you might think that consolidating your debts into a low-rate personal loan is a good move, not reviewing the rate when the honeymoon period ends could cost you big time.

Credit Cards

Credit cards are probably the most common form of passive borrowing strategies. Most credit cards offer an enticing initial low rate. But let’s not forget that credit cards are designed to make money for the banks from interest charges and fees, not save you money.

How to Minimize Passive Borrowing Strategies

Having a goal to reduce your interest costs requires a less passive approach to borrowing. Some key strategies are as follows:

  • Compare rates and get quotes from different lenders. Be sure to look at the fine print and look for any hidden costs or honeymoon periods that may not be obvious from the outset.
  • Monitor market interest rates and refinance as needed. Keep an eye on what’s happening in the economy. When financial analysts and the press start talking about the possibility of rates rising, this would be a good time to start calling lenders to discuss your situation.
  • Diversify your types of loans and borrowings. You may utilize bank loans, peer-to-peer loans, and credit cards, which all come with different interest rates, and pros and cons. Having this range of loan types allows you to strategically move your money between borrowers when needed when trying to reduce your debt. For example, it might make sense to move some of your credit card balance to a low-interest personal loan, rather than continue to pay a high interest rate. And by keeping the credit card you can also utilize the credit card’s rewards program to maximize your benefits.

Passive Borrowing vs Passive Investing

Although they sound related, passive borrowing and passive investing are different concepts. Passive borrowing strategies open you up to increased costs due to rollover risks. Whereas, passive investing is a long-term income strategy to invest in the stock market with little to no active management.

The most common form of passive investing is to include exchange traded funds in your portfolio that track a stock market index. You could also invest in an Index fund managed by a fund manager like Vanguard or JP Morgan Chase.

Passive investing has a number of up-sides:

  • Lower Maintenance: There is no need to actively check the holdings of your portfolio. The stocks in your portfolio are automatically adjusted by the fund manager to align with the index they are tracking.
  • Steady Returns: Most passively managed funds outperform actively managed funds.
  • Lower Fees: Since stocks are not being regularly traded within the fund, passive funds take very little effort from the fund manager to run.
  • Lower Taxes: Most passively managed portfolios hold onto stocks for the long term, which reduces the frequency of taxes from capital gains.

Wrapping Up

Passive borrowing strategies such as HELOCs and credit cards expose you to rollover risk of higher interest rates and increased debt. Keep an eye on economic conditions, and be aware of when your rates are due to increase, so you can start looking around for a better deal.

Author

  • Amber Aldridge

    Amber Aldridge is a Lead Writer at MoneyMaver covering personal finance, budgeting, and debt management. Amber passionately champions the cause of individuals who feel excluded or overlooked in the present-day economy. She is deeply committed to supporting and empowering those who face challenges in today’s economic landscape. With her background as a teacher, she adeptly shares practical advice that truly benefits families striving to manage their finances. “Learning about and making the most of budgeting and debt management has profoundly transformed my life. Being a single mom of 2 kids, I draw from my real-life experiences, and love passing that knowledge onto my readers”.

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