Key terms you should know about margin loans
Lack of access to funds can be a major problem for investors, and many turn to margin loans to increase their investment capacity.
While these loans allow you to borrow money to invest in shares or managed funds, they are a high-risk strategy that is best suited to professional investors with the reserve funds to cover market fluctuations and potentially costly margin calls.
Here’s a glossary of key terms you should know about margin loans to help you decide if it’s a good strategy for you.
Borrowing against property
If you’re a homeowner, you could have some equity in your home. If your property is worth more than the current value of your loan, you can access the difference as equity. You may use that equity to help secure a margin loan to build your investments with your property held as security.
Instalment gearing is essentially supporting a regular savings plan with contributions from a margin loan facility to increase your investment capacity. For example, you deposit a set monthly amount into a savings account along with a drawdown from your margin loan. The combined balance can then be invested in a managed fund.
Instalment warrants are like lay-by for investments. They allow you to buy a portfolio of shares, for example, and then pay them off over time with regular contributions. It’s another strategy investors use to expand their investment capacity beyond the cash they have in the bank.
Loan to Valuation Ratio (LVR)
Your Loan to Valuation Ratio (LVR) is the amount of your loan divided by the total value of your shares. That means your LVR can rise and fall as the value of the shares you own fluctuates. To create a sustainable investment portfolio, you’ll want to try to keep your LVR as low as possible – and most lenders will require you to keep it below a maximum of 70 per cent.1
A margin call happens when your maximum LVR falls below the value of the loan. To resolve a margin call you’ll need to pay off a lump sum of the loan, sell off some of your investments, or provide additional security. It is recommended that you maintain a cash account to cover potential margin calls.
Short selling is a share market strategy that flies in the face of the ‘buy low, sell high’ mantra. Short sellers identify shares they believe will decline in value, borrow the shares, then sell them before the predicted price fall. They then close the position – and profit – by buying back the shares at a lower price after their value has dropped.
Looking to give your investment portfolio a boost? Start comparing margin loans from a range of providers now.