What is a margin loan?

If you are a seasoned investor, it is a good idea to be familiar with the concept of a margin loan. If you would like to learn more about this form of borrowing and how it could advantage you, continue reading the article below.

What is it?

A margin loan is a form of loan which allows the borrower to receive money to invest in shares, ETFs and managed funds. One of the main characteristics of a margin loan is its loan to value ratio (LTV) which is the value of your loan divided by the value of your investment. Lenders usually require this percentage to be kept below an agreed level, typically 70%.

If your investments decrease in value or the value of your loan increases, your LVR will also increase. In the event that your LVR exceeds the stipulated level, borrowers generally receive a marginal call from lenders which provides them with the opportunity to lower the LVR back to the agreed level within 24 hours.

There are several ways a borrower can lower their LVR and include:

  • Depositing additional money to reduce the margin loan balance
  • Adding more shares and managed funds to increase the value of your portfolio
  • Selling a portion of your portfolio to pay off some of the margin loan

If borrowers fail to do this within the provided time frame, the lender will sell some of the investments you hold in order to lower your LVR.

Why would you borrow to invest?

Borrowing to invest is a very high-risk strategy and is likely to be more suitable for experienced investors. It is usually recommended that investors wishing to obtain a margin loan have an investment time horizon of at least five to ten years. Your investment portfolio which is made up of individual shares, ETFs and managed funds acts as security for the loan, and therefore investors need to consider whether this is the best strategy for them.

Investment property loans are also available to investors who wish to invest in land, houses, apartments or commercial property. Instead of making a return through an increase in the value of shares or ETFs, investors can earn income through rent and an increase in the value of the property. However, this is also accompanied by interest on the loan as well as the costs of owning a property. These costs include council rates, insurance, repairs and often conveyancing fees. To read more about whether to invest in property or shares, click here.

Although borrowing does provide investors with a greater capacity to grow their wealth, the more an investor borrows, the more they have to lose.

What are the risks?

Before making any decisions that can affect your financial position it is important to be well acquainted with all the risks and costs of a particular course of action. Below are some of the key risks investors need to keep in mind before taking out a margin loan.

  1. Loss

Borrowing to invest increases the amount an investor will lose if their investment falls in value. Irrespective of whether your investment value decreases, borrowers will still be required to pay their margin loan and its interests whether or not the market has performed in your favour.

  1. Capital loss

If you need to liquidate your investment at a shorter than expected time frame, you may be forced to sell when market conditions are less than optimal. This is likely to lead to a loss of capital which could mean that you have to use other funds to cover the balance of the loan.

  1. Income risk

Another risk for investors to consider is that the projected income or returns they expected to receive from their investment may not materialise. Any form of investing is risky, especially with a margin loan and hence it is important for investors to have sufficient cash flow to cover both their cost of living and the loan in the event your portfolio generates fewer returns.

  1. Interest rate risk

If you choose to take out a loan that has a variable rate, the interest rate and subsequent repayments can change and may increase. Therefore, it is important that investors forecast whether they would be able to satisfy loan repayments if the associated interest rate increased.

Clients of EPG Wealth are provided with an analysis of the different options available to them which allows them to make informed choices about their financial position and investment journey. If you would like tailored assistance with your investment strategy, please click here to organise a complimentary 20-minute phone call with an EPG Wealth adviser to see if we can help you.

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