Margin lending explained
A margin loan is a type of investment loan that lets you borrow money to invest in shares, managed funds and other approved financial products.
Using a margin loan to amplify your investing power can be an effective way to build wealth, diversify your portfolio and could offer tax benefits as well. However, just as it has the potential to grow your wealth, if stocks go down in value your losses will be amplified as well. It’s important to weigh up both the benefits and the risks when thinking about investing with a margin loan.
How does a margin loan work?
A margin loan uses existing shares, managed funds and cash as security. These existing assets are used to calculate your Loan to Value Ratio (LVR), which determines how much you can borrow. Once your borrowing limit is established, you can use available funds to purchase further approved investments (shares, managed funds etc). Your new and existing investments are combined to form your total portfolio.
Interest on a margin loan is calculated daily; but how it is paid will depend on the loan. Some margin loans allow interest to be paid in advance.
What are some of the benefits?
Boost your investing power - increasing the size of your investments could amplify your profits in a rising market as well as increase the size of any dividend payments
Diversify your portfolio - access to more funds means you could diversify across different asset classes, industries and companies. This in turn could also help reduce investment risk.
Potential tax advantages - depending on your circumstances you may be able to claim tax deductions for some or all of your borrowing costs.
What about the risks?
Amplified losses - just as borrowing to invest can increase profits, it can also amplify your losses should the market turn against you
Interest rate changes - unless you’ve opted for a fixed rate margin loan, interest rates could change at any time increasing the overall cost of your investments as well as potentially reducing profits.
Margin calls - if the overall value of your portfolio falls to an extent that it exceeds your LVR, you’ll need to resolve/satisfy a margin call.
How does a margin call work?
If the market moves against you and the LVR goes over the borrowing amount, you’ll get what is known as a margin call from your lender. This means you’ll need to top up the balance of your loan to get it beneath the agreed borrowing limit. There are three different ways you can do this:
- Top up the loan balance with cash
- Sell some of your portfolio and use the proceeds to repay a portion of the loan
- Transfer existing securities not currently being used as security on the loan to increase the borrowing limit
Things you should know
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