What is a Margin Call?
If your lender makes a margin call, you are required to reduce your LVR by putting more money into your loan or selling some of your assets.
To simplify it, a margin call:
· Is a request from your lender to reduce your LVR.
· Requires you to pay your lender, sell your assets or give your lender ownership of your assets.
Lenders use an LVR to determine the risk of your loan. This is the percentage of your loan in comparison to the value of your investment.
For example, if your loan is for $25,000 and your investment portfolio is valued at $75,000, your LVR is 33%. However, if your loan is for $25,000 and the value of your investment falls to $30,000, your LVR is 83%. At this point your lender will like make a margin call.
When will you face a margin call?
Your lender will place a borrowing limit on you, plus a buffer – usually 5%. For instance, they may have a minimum LVR of 75% and a buffer of 5%. This means that when the trading price of your investments falls to the point that you owe more than 80% of the value of your security, you’ll face a margin call.
Once this happens, you’ll be required to put more money into your loan, or provide additional security to reduce your LVR.
For example, say you own 1,000 shares in Company X, originally valued at $10 each. When you took out a margin loan to buy these shares, you provided $2,500 in cash and borrowed $7,500, giving you an LVR of 75%, which is also your lender's maximum.
Let’s say Company X releases poor financial data and the value of its shares falls to $8.50. Suddenly, you owe $7,500 on shares worth only $8,500. Now your LVR is almost 88%, well beyond the bank's maximum.
As 75% of $8,500 is $6,375 and you owe $7,500, your lender may issue a margin call, asking you to find an extra $1,125 to meet its minimum LVR requirement.
What are your options when you’re subject to a margin call?
Generally, you have three main options:
1 Deposit money into your loan account: If you have the funds available, you can transfer money into your loan account so that you meet the value of the margin call.
2 Transfer approved securities to cover the value: Sometimes lenders will let you cover the amount of the margin call by putting up additional security in the form of other shares, managed funds or cash.
3 Sell some of your assets: Finally, if you don’t have the funds to meet either of the first two options, you may be forced to sell some of your assets. This, however, can have a major impact on your investment and lead to losing a substantial amount of money. For instance, using the same example as above, you would need to sell 400 of your 1,000 shares in Company X at $8.50 each just to bring your LVR back into balance.
If you're interested in borrowing to fund your investment, most trading platforms offer investors the chance to take out margin loans.