What is a margin loan?
A margin loan is a type of loan that allows you to borrow funds to invest in shares, managed funds and other securities. Although not suitable for all investors, it can help you reach your financial goals sooner, but it can also amplify your losses.
How do margin loans work?
Taking out a margin loan is similar to taking out a home loan, as you will have to pay interest and eventually repay the money you borrowed in full. However, with a margin loan the investor’s portfolio of shares or managed funds, for example, provide the security for the loan as opposed to a house. This means that the margin loans provider can sell your shares to repay the loan, if necessary.
A few terms to get you started
The Loan to Value Ratio (LVR) is used by the lender to measure the risk of your loan. The LVR is based on the value of a security and represents how much you can borrow as a percentage of the total value of your investment. For example, if stocks have an LVR of 70% this means the lender will loan you 70% on the condition that you can provide the other 30%.
A margin call is issued when the equity in a margin account falls below a certain level and typically each margin lender sets their own margin requirements. A margin call can be quite scary for investors as not only does it mean that the value of your investments has fallen, but if you aren’t able to provide additional funds to boost up your portfolio, then the broker can sell off your assets.
Learn more about margin calls here.
So, should investors buy on margin?
The needs of each individual will be different, so it depends on your situation as to whether or not a margin loan is right for you. It’s a good idea to explore the pros and cons and fully understand the risks involved before taking out a margin loan.
There are a number of advantages to taking out a margin loan, including the potential to increase the size of your returns. Additionally, some brokers allow you to borrow small amounts initially and there may be some tax advantages. On the other hand, as a result of market volatility margin calls are a real risk, lenders can also change the LVR at any point and while your gains will typically be stronger, any losses you experience will also be magnified.
Related article: The Pros and Cons of a Margin Loan
How to choose a margin loan
Each lender will have their own terms to be aware of, so it always pays to shop around. For example, some brokers don’t perform margin calls, such as with NAB’s Equity Builder. While others have a lower interest rate that can even be fixed. Those looking to start small may be attracted to lenders who don’t have a minimum loan amount, such as CommSec’s Margin Loan. The scope of investment products also differs between lenders. Some have a wide range of investment products that you can invest in using your loan, while the offering from others can be limited. Here are a few things to consider before deciding on a margin lender:
- your capacity to repay the loan
- the interest rate on offer
- the investment products you want to invest in
It may also be worth having a strategy in place in the instance that a margin call is issued on your account.
To see our 5-Star Rated Margin Loans for 2019, check out this article.