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Helpful Information on Margin Lending

What is a margin loan?

A margin loan is a loan where you borrow money to invest in the share market, and you use your share portfolio or managed funds portfolio as security for the loan. Since a margin loan carries the risk of margin calls, a margin loan can either increase your returns (if your portfolio increases in value) or dramatically magnify your losses (if the value of your portfolio drops).

Margin loans have slowly been declining in popularity since the GFC. According to Reserve Bank of Australia (RBA) statistics from June 2016, there are currently 137,000 margin lending accounts in the system, down from 144,000 in June 2015 and 248,000 in June 2008, pre-GFC. As for how much investors take out in margin loans, we reached $11.8 billion in margin loans in June 2016, down from $12.4 billion in June 2015.

 

How do margin loans work?

When you take out a margin loan to buy shares, the lender’s security is in the shares you own. So the lender has the right to sell your shares to repay the loan if your shares lose too much value, you are unable to pay off your loan, or you fail to pay a margin call.

See below for the many risks involved in margin loans, including the dreaded margin call.

 

What is an LVR?

‘LVR’ stands for the loan-to-value or loan-to-valuation ratio. When a loan is being used to invest in something that is the security for the loan, lenders will only lend a percentage of the purchase price of that investment.

You can calculate your LVR by dividing the amount of your loan by the total value of your shares. Most lenders require you to keep the LVR below a maximum of 70%.

When it comes to choosing a margin loan, you should definitely shop around. Since margin loans carry a significant financial risk, you need to look for a great value loan that suits your needs.

Margin lending lets you borrow money to invest in shares or managed funds. Consumers usually have a preference for investing in one primary security, either shares or managed funds, but may also invest in their secondary security type.

CANSTAR assesses margin loans from the perspectives of two different consumer profiles, to take into account that these two categories of investor have different priorities.

  1. Share Investor: A Share Investor’s securities are typically 90% shares and 10% managed funds.
  2. Managed Fund Investor: A Managed Fund Investor’s securities are typically 80% managed funds and 20% shares.

 

Compare margin loans on our CANSTAR website or read our most recent margin lending star ratings report for more information.

We suggest that you look for a margin loan that has at minimum the following features:

  • Different interest rate options – variable rate, fixed rate, and interest in advance on fixed rate loans.
  • Choice of acceptable securities – Australian shares, managed funds, international shares, and instalment warrants.
  • An appropriate borrowing limit, shown on the Loan to Value Ratios (LVR) in the product disclosure statement.
  • Higher buffer levels can reduce the probability and frequency of margin calls.
  • A good link between the lender and the broker, so that a margin call can be dealt with easily.
  • Brokers who are approved by the lender and have reasonable brokerage fees.
  • Online brokers and online customer support available, to allow user-friendly monitoring of your investment portfolio.

What are the risks in taking out a margin loan?

The main risk in taking out a margin loan is the usual market fluctuation that affects all types of share investing.

But as ASIC points out, margin loans also carry some additional risks:

  • An unexpected margin call can be made.
  • You can be forced to sell your shares at a low price to meet a margin call.
  • Your lender could lower the maximum allowable LVR for your loan, increasing the probability of a margin call being made.
  • If the market falls far enough, you could end up owing more than your original investment in the shares was worth.
  • You could be forced to pay off your loan at short notice if your lender decides your share portfolio is no longer adequate security.

ASIC’s MoneySmart has a useful Margin Loan Calculator to help you calculate the likely risks of taking out a margin loan, and how much money you would need to have at hand if a margin call was made.

 

What is a margin call?

A margin call is an order from your broker or your lender for you as an investor to pay the difference between the value of your stocks and the balance of your loan. A margin call will be made at the end of the day’s trading if the value of your stock has fallen below the amount of your loan balance plus your borrowing buffer amount.

The margin call must usually be paid within 24 hours, and you can pay the amount by cash or by transferring stocks or additional security (such as property you own) into your portfolio. Then you must notify your lender to confirm that the margin call has been met. If you cannot pay, your broker or lender will sell your stocks to bring your loan balance back to below your LVR.

Lenders typically build a buffer in to the value of your investment of:

  • 5% for shares with an LVR higher than 75%
  • 10% for shares with an LVR of 75% or less
  • 10% for managed funds

As of January 2011, lenders are required under Australian credit laws to contact investors when they make a margin call. But it is still your responsibility to monitor your stocks.

You can prevent a margin call by taking action any time you creep into the buffer zone, to bring your balance back down below the appropriate LVR. You can calculate your own LVR at any time by dividing the amount of your loan by the total value of your portfolio. We have provided some example calculations in our article, What is an LVR?

You can also reduce the probability of a margin call by changing your investment strategies:

  • Monitor your stock portfolio and your loan regularly, and keep away from the maximum LVR.
  • Diversify your portfolio to cope with volatility in the market.
  • Borrow conservatively, by borrowing less than half the maximum amount a lender is willing to lend you.
  • Get advice from a qualified financial adviser.
  • Pay off the interest on your loan regularly. You can even do this by reinvesting the investment income back into your loan.
  • Have a strategy in place for being able to pay a margin call.
  • Ensure your investment timeframe is long-term (longer than 5 years).

Please note that these are a general explanation of the meaning of terms used in relation to margin loans. Policy wording may use different terms and you should read the terms and conditions of the relevant loan to understand the inclusions and exclusions of that policy. You cannot rely on these terms to the part of any loan you may take out. You should refer to the product disclosure statement.

For further terms used in relation to share trading, see our Online Share Trading glossary of terms.

Approved securities: A lender’s list of securities (shares and managed funds) against which they are willing to lend money. A maximum LVR will be assigned to each approved security.

Asset: A resource that is controlled by a person because they own it or own an interest in it.

Balance: The amount remaining to be paid off on your loan.

Bankruptcy: This is when someone’s debt problems become so serious that they are unable to pay their existing debts and bills. When this happens, they can apply to a court to be declared bankrupt, and any assets or savings they have can be used to pay off their debts. Normally after one year a person will be discharged from bankruptcy, but it will still have a negative impact on their credit rating and may stop them from getting a loan or credit card in the future.

Basis points: A basis point is equal to 0.01% interest. For example, 50 basis points is an interest rate of 0.50%.

Borrower or Debtor: A person who borrows money from a financial institution in the form of a loan.

Brokerage: Fees you pay a stockbroker for them to buy or sell shares for you.

Buffer: Lenders will generally allow your LVR to exceed your limit by a certain percentage before making a margin call. The buffer is typically 5% to 10% above the maximum LVR.

Credit report or credit history: A report from a credit agency that contains a history of your previous loan and bill payments. Banks, lenders, creditors and financial institutions use this report and your credit rating to determine how likely you are to repay a future debt and whether or not they should lend money to you. Find out more about what is included in your credit report here.

Credit rating or credit score: A numerical score that represents your trustworthiness to be given credit or a loan, based on your positive and negative borrowing and repayment history. Your credit rating and credit report are used by lenders when deciding whether or not to lend to you. Find out how to check your credit score here.

Debt: Money owed by one person (the debtor/borrower) to another person or financial institution (the creditor/lender) under a contract. A loan is a type of debt. Also known as a liability.

Default: When a cardholder fails to make the minimum required payments on their loan. Defaults are a serious black mark on your credit report and negatively affect your credit rating. A default can result in higher interest rates being charged on your loan.

Dividend: A portion of the company’s net profit is distributed to its shareholders. This is usually expressed as a number of cents distributed per share owned.

Drawdown: When a lender “draws down” the loan from their funds into your bank account, and you use the money by buying shares or another investment. Interest is typically charged from the date your loan funds are drawn down into your bank account.

Drawdown Date: The date on which you first use the loaned money to buy shares or another investment.

Equity: Where you have borrowed money to buy an asset, such as shares or property, equity means the difference between the value of the asset and how much you owe on it. For example, when an owner has bought shares for $10,000 and repays $6,000, they now have equity of $4,000.

Equity access loan: A margin loan that allows an investor to use a portion of the credit limit in their home loan (their “equity”) as security for their investment borrowing.

Fixed rate: A loan where the borrower locks in a certain interest rate for a period of time. During that time, they pay the same interest rate every month in their repayments, regardless of movements in the RBA official cash rate. At the end of the fixed rate period, the loan may revert to a variable rate, or the lender and borrower can agree to another fixed rate. Some loans even offer a fixed rate for the life of the loan.

Guarantee: An undertaking or promise by someone to pay the balance of the loan if the borrower fails to meet the required repayments.

Interest rate: The rate at which the outstanding balance of your loan increases per month if it is not paid in full.

Lender or Creditor: The financial institution offering the loan to a borrower.

Loan: An amount of money borrowed by one person from a financial institution or other lender. The amount must be repaid, and interest is charged on the amount until it is fully repaid.

LVR (Loan to Value Ratio or Loan to Valuation Ratio): The amount you can borrow, represented as a percentage of the value of the property you are buying, which is being used as security for the loan.

Margin call: An order from your broker or your lender for you as an investor to pay the difference between the value of your stocks and the balance of your loan. This amount can be paid by cash or by transferring stocks into your portfolio, but if you cannot pay, your broker or lender will sell your stocks to pay the amount. A margin call is made at the end of trading if your stocks’ value has fallen below the amount of your loan balance plus your borrowing buffer amount.

Maximum loan amount: The maximum amount that you can borrow from the lender for a loan.

Minimum interest charge: The minimum amount of interest that will be charged on your balance. For example, if your total interest charge for a statement is $0.75 but the bank’s minimum interest charge is $1.00, you will be charged $1.00.

Minimum repayment: The amount listed as the minimum interest and repayment your bank requires you to pay off your loan for that month.

Negative gearing: When the income produced by the investment (dividends from shares) is less than the interest being paid on the loan used to buy the investment. This is usually an available tax deduction.

Ombudsman: If you have a dispute with your bank and haven’t been able to resolve it through the lender’s internal complaints resolution process, you can contact Australia’s free Ombudsman services to resolve it. Contact the Credit and Investments Ombudsman or the Financial Ombudsman Service of Australia.

Pre-payment: Many lenders allow investors to pay their interest in advance, sometimes a year in advance. An interest payment made for the coming financial year can be a tax deduction against the current financial year’s income.

RBA cash rate: The overnight interest rate that the Reserve Bank of Australia offers financial institutions to settle-up on inter-bank transactions. This cash rate influences the interest rate that lenders charge their customers.

Secured loan: A loan where the borrower provides an asset as security (insurance) for their debt. Because the loan is “insured” by this security, secured loans usually have lower interest rates than unsecured loans.

Security: An asset that is offered as insurance or a guarantee to pay the loan. In the case of margin loans, the security is usually the investor’s share or managed fund portfolio. If a borrower cannot repay the loan or meet a margin call, the lender has the right to sell the secured shares or managed fund portfolio as payment.

Shares: A portion of the ownership rights to a company. Shareholders receive a portion of the profits if the company does well, in the form of dividends. However, if the company does poorly, the shareholder has effectively lost money. Also known as a company’s “stock”.

Stock: Shares.

Unsecured loan: A loan where the borrower does not provide any asset as security (insurance) for their debt. Because the loan is not “insured” by any security, it is a higher risk, so lenders charge higher interest rates than secured loans.

How we rate margin loans:

Every year, we analyse over 250 features of the margin loans on our ever-growing database, for the two investor profiles of Share Investor and Managed Fund Investor.

We compare margin loans according to characteristics including the following:

  • Interest rates
  • Features
  • Fees and charges
  • Number of shares/funds available
  • Loan to Value Ratio (LVR)

For more details about the way we rate various features, read the methodology in our latest star ratings report.

 

Margin loan providers we research and rate:

The personal loan providers we rate are listed on our margin loan comparison website. The following list is current as at August 2016:

  1. ANZ: You can apply for an ANZ share investment loan through a broker or through E*Trade. You can calculate the approximate security value of your share portfolio using their diversified margin lending calculator. Their Grow app allows you to track your investments on Apple devices. ANZ has a long history, founded in 1835 in Sydney as the Bank of Australasia.
  2. BT: You can view BT margin lending interest rates on their website. BT Financial Group was founded in 1969 and is the wealth management arm of the Westpac Group.
  3. CommSec and CommSec Adviser Services: The CommSec app allows you to trade on Apple or Android devices. CommSec Advisory provides full-service stockbroking and investment advice. The Commonwealth Bank is Australia’s largest provider of financial services, founded in 1911 as the government bank for our young nation.
  4. NAB: You can view NAB margin lending interest rates on their website. Investors can write a call option allowing NAB to buy their shares at a specified price if a margin call is made. NAB was founded in 1981 and is one of the big four banks in Australia, with over 12.7 million customers worldwide.
  5. George: St. George is best known as the bank with the dragon logo. It was founded in 1937 and has 2.6 million customers in Australia.
  6. Suncorp Bank: You can view current Suncorp margin lending interest rates on their website. Suncorp was founded in 1902 and remains Australia’s leading bank in regional areas.
  7. Morgan Stanley Smith Barney (MSSB): Morgan Stanley was formerly known as Citi Smith Barney until 2013, when Morgan Stanley Parent bought out Citi’s interest in the company.
  8. Westpac: Westpac was established in 1817 as the Bank of New South Wales and serves around 13 million customers, as one of the big four Australian banks.