What is a Margin Loan?
A margin loan is a way for sophisticated investors to grow their portfolio by borrowing money from a financial institution.
What is a margin loan?
To break it down, a margin loan:
· Is money you borrow from the bank for the purpose of buying shares or investing in a managed fund.
· Uses your investment portfolio as security against the loan.
· Comes with a variable or fixed interest rate.
· Can include repayments that are made against both the principal loan and the interest, or it can be interest-only.
When you take out a margin loan, most lenders will restrict you to buying from an approved list of shares and managed funds. This is to ensure you don’t put money into a high-risk investment.
Margin loans are not for everyone – they are for experienced investors, who understand the risks. If the value of your shares or managed fund goes up, having a margin loan will amplify your gains. If their value goes down, it will also amplify your losses. This means using a margin loan increases the risk involved in share trading.
Why take out a margin loan?
If you are a sophisticated investor, it might make sense to use a margin loan:
· When you want greater exposure to the market: Margin lending lets you acquire more shares or managed funds than you’d otherwise be able to. This could help you reach your financial goals sooner.
· When you want greater diversity: Borrowing gives you the chance to spread your investments. By diversifying your portfolio, you can reduce risks.
· For tax reasons: Any interest you pay on a margin loan may be tax deductible. There may also be capital gains tax (CGT) advantages in borrowing against your existing portfolio to acquire more shares.
· When you’re investing for the long term: If you’re prepared to make regular contributions to your margin loan, you may end up with a significant asset over time.
How does a margin loan work?
Before you take out a margin loan, make sure you understand how they work and what your risks and financial responsibilities are.
· Making a deposit: Your deposit will usually be made up of cash, shares and managed funds that you already own. Your lender will use these to calculate how much you can borrow. But to minimise your risk, consider borrowing less than the maximum amount.
· Your loan-to-value ratio (LVR): Your lender will insist that you meet a particular LVR. This may vary from asset to asset, depending on the risk involved. For instance, you may be able to borrow more against a blue-chip share than against a smaller company. Your lender will likely monitor the value of investments and your LVR on a daily basis to ensure it stays within the agreed limit.
· Margin calls: If the value of your shares or managed fund dips below the agreed LVR, your lender may expect you to contribute extra funds. This is known as a ‘margin call’. If you can’t meet this payment, you may be forced to sell your assets at a loss in order to repay your lender.
· Repayments: You'll need to make regular repayments to your margin loan, and may choose to pay off both principal and interest, or opt for interest-only. Some lenders also let you choose between a fixed or variable interest rate, and some margin loans even include the option to pay interest in advance.
Margin loans are not for everyone and they are not a good idea for inexperienced investors. Whether or not margin lending is right for you will depend on your investment goals and strategies, as well as your personal circumstances.