A margin call is a request from your lender to reduce the loan-to-value ratio (LVR) of your margin loan by depositing additional funds or selling some of your assets. This process occurs occurs when shares you have purchased through a margin loan may have fallen, requiring you to top up your equity share.
What is your LVR?
Lenders use your LVR to determine the risk of your margin loan. This is the percentage of your loan in comparison to the value of your investment which can include shares, managed funds or cash to be used as a form of security. In most cases, the larger and more stable the company to be invested in, the higher the LVR than those considered smaller and more volatile.
When can you face a margin call?
If the portion of your financial portfolio used as security drops due to a loss in share price, you may exceed the maximum LVR required for your margin loan. As a result, a margin call is triggered and you will be required to:
- Reduce your loan amount, or
- Contribute additional security to your portfolio in the form of cash or another asset, or
- Sell part of your investment until your LVR is below the maximum requirement.
Generally with a margin loan, a lender will place a borrowing limit on you, plus a buffer - usually 5%. For instance, they may have a minimum LVR requirement 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.
Say you own 1,000 shares in a company, 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. Upon releasing its quarterly results to close out the year, the company you have invested shares into through your margin loan has not performed as well as expected, with the value of its shares falling 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 faced with a margin call?
To remove the margin call in place by your lender, generally, you have three main options:
- Deposit money into your margin 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.
- 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.
- 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.
It is important to recognise that all forms of investing bear risks, with marginal lending generally being at the riskier end of the spectrum. On one side of the coin borrowing to invest a greater amount of money in shares or managed funds may present the opportunity to increase potential returns, however on the other side a margin loan can also magnify losses. If you're interested in borrowing to fund your investment portfolio, it's important to take the time to carefully research your investments. Start by comparing margin loans through InfoChoice's comparison table to determine exactly how much you have to invest.