Having debt is widely viewed as something negative, but taking out a specific type of loan could actually help you become significantly better off.

People often aspire to be ‘debt free’ and make this a primary financial goal. There are good reasons for this in many cases, and it will be a wise move for a lot of people.

Outside of a mortgage, which is an essential part of buying a home for the vast majority, spending money on paying interest is not a good way to improve your financial standing.

There is a crucial distinction that must drawn between two very different types of debt though.

One is debt that exists because you do not have the money to pay it off immediately - but the other is debt you choose to have because it offers advantages.

Borrowing against your investment pot

For people who own an investment portfolio, taking on debt of the right kind at the right time through choice, rather than necessity, is a route to increasing wealth over time.

The key to this is that money received in the form of a loan is not subject to tax, as it is not a form of income or a capital gain.

An investment-backed loan, also known as a Lombard loan, is a credit facility provided by private banks, wealth managers or stockbrokers to their clients, secured against their portfolio of assets. The fact that Lombard loans are backed by assets means they are considered low risk for the lender, and therefore relatively low interest rates can be charged.

The name goes all the way back to the Middle Ages, when merchants and bankers in the Lombardy region of Italy engaged in similar practices.

“The main perceived advantage is that it allows investors to access funds without selling investments, which can defer a capital gains tax bill,” says Ian Cook, a chartered financial planner at Quilter Cheviot.

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“It may also help preserve long-term investment positions that would otherwise need to be sold to raise cash. From an inheritance tax perspective, borrowing can sometimes form part of a wider estate planning strategy where the loan is used to fund lifetime gifting or reduce the value of an estate.

“However, the tax benefits are secondary to the practical purpose of providing liquidity, and anyone considering this route should seek specialist advice as the tax implications can be complex and situation dependent.”

Advantages of ‘good’ debts

Another big benefit is that your assets are likely to be going up in value over time, provided they are sensibly chosen and diversified. The rise in the value of the assets you still own could substantially outweigh the cost of the interest on the loan.

In this favourable scenario, not only are you saving the 24 per cent capital gains tax that could have been charged if you sold the assets to get hold of the cash, but the loan is effectively interest free.

“Typically, clients use these loans to meet short-term cash needs such as funding a property purchase, paying a tax bill, or making a business or investment opportunity that would otherwise require liquidating part of their portfolio,” Cook further explained.

“The key consideration is that the loan should have a clear and finite purpose, and there should be a realistic repayment plan in place from the outset.”

Who can get a Lombard loan?

While being a private banking or wealth management client has traditionally been seen as the preserve of a small number of very wealthy people, that is not actually the case.

While different firms have varying criteria, private banking services such as Lombard loans can be available to anyone with around £250,000 of liquid assets or more.

That is not an insignificant figure, but it is far from multi-millionaire level. For example, somebody on an average salary who has built up a pension pot steadily over decades could draw down up to £268,275 tax free from aged 55.

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Many more people will come into such amounts of money over the coming decade as the so-called “great wealth transfer” from the post-war generation to their children and grandchildren accelerates.

Data on Lombard loans is very scarce as private banks and wealth managers are famed for the privacy they offer their clients. A report from consulting firm Deloitte last year offered an estimate of $4.3tn (£3.3tn) for the total amount of Lombard loans issued, with an annual growth rate of between 5 and 10 per cent.

What about the risks?

Like most things in life, there are risks attached. The principle one being that the value of the investments in your portfolio could fall rather than appreciate.

“The risks are substantial and must not be overlooked,” Cook said. “If markets fall and the value of the underlying investments declines, the lender may demand additional collateral or repayment at short notice, known as a margin call.

“Interest costs can also erode returns, particularly in a higher rate environment, and if the portfolio is used to service the debt this can create a negative spiral. There is also the behavioural risk that easy access to credit encourages over borrowing or speculative activity.

“For these reasons, borrowing against investments should only ever be done under professional advice and with a clear understanding of both the risks and costs involved.”

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.