One of the other ways which people try to secure their money is by investing.
Perhaps you have an existing investment and are looking to expand on that portfolio because of how rewarding it is, well that’s what we’re here to guide you through, the option of using margin loans to expand your investments.
Everyone’s trying to be smart with their money, well, almost everyone, but mostly that’s the trend these days. Everywhere you turn there are loyalty programs and reward programs, cash back features and quick cash loans that suit your wallet and lifestyle.
What are margin loans?
Let’s say you invest in a specific share or shares for that matter, and it’s looking up and because you’re such a well-read stock market guru! Not only do you understand the trends but you are certain that, in the next few months the more money you invest, the more money you’re going to make! One problem, you don’t have any additional money to throw at this investment. If only you could borrow the money, and pay it back once you’ve made your money? Well, that’s where margin loans come in.
Margin loans essentially provide you with credit to purchase investments or add to current investments. Thus, combining your current equity with new, borrowed money to essentially help you make a lot more money!
But as with anything financial, there are risks that you absolutely have to be aware of. And in order to be eligible for a margin loan, you’ll need to offer security in the form of cash or any ASX-listed shares that you already own.
So how much can I borrow?
This amount will depend on the value of your current investments coupled with the security offer you made in the beginning in order to apply for the loan. There is also the consideration of the Loan to Value Ratio aka LVR, which financial companies set, and equals the amount of money you can borrow vs the cost of shares.
When it comes to shares, they each come with their own LVR, and lenders will each have their own list detailing the amounts you’re able to borrow. That way, you know exactly what you’re getting when it comes to the lender and the investor!
Example of a margin loan
You need to buy shares to the value of $20,000 and the LVR is 80% - you’ll be able to borrow $16,000 and provide $4,000 as security for the margin loan. The equation is quite simple and the higher the value of your security, the more access you will have to additional investment funds.
Types of Margin loans
1. Variable rate loan
This is a flexible rate loan that when the interest rate increases and decreases with the economic climate of the country, i.e. the cash rate influences how much interest you will pay each month. Meaning, if the Reserve Bank of Australia (RBA) increases the cash rate, your interest goes up, ergo raising your repayments and vice versa.
2. Fixed rate loan
This is when the interest rate is fixed, therefore any changes in the interest rate will in no way affect your repayments for the full period of the loan until it is settled. Budgeting is far easier with this loan type but you may be missing out on great interest rate changes!
Margin loan interest type
With margin loans you only need to pay interest on the amount of money you actually use and this interest can be paid either in advance or in arrears. Look at your affordability when it comes to choosing between fixed and variable rates and the options that are available.
The features of margin loans
- Options trading: Lenders often offer this feature for when the market forecast is uncertain. You’ll find sophisticated investors making use of such tools when borrowing money.
- Mixed collateral: One can use multiple types of security against the margin loan, such as property and your shares or current investments.
- Interest in advance: Exactly as it states – you have the option to pay the interest upfront!
- Gearing: This is when one chooses to borrow funds to invest.
- International shares: The loan can offer you the funds to invest in international shares.
Risks associated with margin loans
A massive risk is that you may have no idea what your return on investment will be. You have invested in something that you hope will bring in enough money for everything to work out the way you planned, but as we know, shares can fall, fear can take over, and big losses can be incurred.
The security on your loan is also a huge risk. Understand that if you have put your home as security on the loan and you are unable to repay the loan, your home is at risk and that isn’t something we should take on lightly.
If your investment looks to drop beneath the LVR of your loan, you will need to make what is called a 'margin call' and add assets and such to your investment, this is an unfavourable way of doing things, and is referred to as negative gearing.
There are laws to protect borrowers of margin loans, but let’s be fair, there is a level of responsibility anyone that chooses to apply for margin loans.
Ask yourself the following before you apply for a margin loan
- What am I at risk for with a margin loan?
- Do I fully understand the ins and outs of margin loans?
- Can I benefit from tax reductions at all on this loan?
- Who owns my shares in terms of borrowed money invested?
- Is there such a thing as investment protection when markets fall?