A margin loan, sometimes known as an investment loan, is a secured line of credit that allows you to borrow funds to invest. The loan is secured over your existing shares, ETF’s or managed funds which will all have an assigned loan to value ratio (LVR) which will determine how much you can borrow.
Benefits of using a Margin Loan
- Ability to purchase a larger investment portfolio
- Additional funds can be used to diversify your investments
- Opportunity to potentially increase the gross return on your own equity using the leverage
The below table demonstrates the impact using a margin loan can have on a portfolio geared at different LVR’s.
Risks of Margin Lending
Before considering margin lending as part of your investment strategy, you should understand that in addition to increasing your potential for profit, you also increase the potential risk associated with your investment.
- Bigger losses — Borrowing to invest increases the amount you'll lose if your investments falls in value. You need to repay the loan and interest regardless of how your investment goes.
- Capital risk — The value of your investment can go down. If you have to sell the investment quickly it may not cover the loan balance. You also need to be aware that a margin loan is a “full recourse” loan. This means that even if the value of your security portfolio falls to zero, you are still liable to repay the total loan balance outstanding.
- Investment income risk — The income from an investment may be lower than expected. For example, a company may not pay a dividend. Make sure you can cover living costs and loan repayments if you don't get any investment income.
- Interest rate risk — If you have a variable rate loan, the interest rate and interest payments can increase. If interest rates went up by 2% or 4%, could you still afford the repayments?
Margin Calls
A margin call will occur in the portfolio should the value be reduced below the acceptable LVR. In this case the borrower will be required to contribute additional collateral by way of a margin call to reduce the loan balance and bring the LVR back to an acceptable level.
The acceptable LVR is dependent upon the type and number of shares within the portfolio. As an alternative to contributing additional collateral, the borrower could also sell shares to reduce the balance of the loan. Should a margin call be made, action must be taken within 24 hours to rectify the situation.
If you would like to discuss how you can use Margin Lending as part of your portfolio, please contact Simon at [email protected] or via (02) 4325 0884.
Simon Tarrant is a Private Client Adviser at Morgans Gosford. Simon is passionate about creating quality financial strategies that are tailored and customised to an investor’s individual lifestyle, financial goals and risk profile.
General Advice warning: This article is made without consideration of any specific client’s investment objectives, financial situation or needs. It is recommended that any persons who wish to act upon this report consult with their investment adviser before doing so. Morgans does not accept any liability for the results of any actions taken or not taken on the basis of information in this report, or for any negligent misstatements, errors or omissions.
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