What is a Margin Loan?
A margin loan is not your typical kind of loan. It is ideal for investors who frequently keep an eye on their investments. It allows investors to borrow money to buy shares or invest and use it as a guarantee. In case you barely have the time to monitor the movement of shares then do not go for it. It is mainly intended for dedicated investors who understand how margin loans work. It is a high risk type of loan which can help you increase your returns or lose a lot of money.
How it works?
Share prices are not just unpredictable but they also move frequently, it can go high or low. Many are into it because they earn heaps from it. Here’s an example. Say you have a number of shares and you earned incredible returns, you have the desire to buy more shares but you have insufficient funds. You borrow money to produce the cash. The lender will now take the shares as security or collateral. In case you are not able to repay the loan, the lender can sell it to recover the capital.
Margin Loan Risk
Why is it risky? Share prices are highly exposed to risk. Share value may rise or fall depending on certain circumstances. How do you determine the risk of your loan? Lenders gauge it by using Loan to Value Ratio or LVR. You can calculate it by dividing the amount of loan against the value of shares. Lenders will ask you to maintain the LVR below 70%. If the value of shares drop and you have reached the maximum LVR, you will be required to repay a portion of the loan or what you call a margin call. It is necessary to meet the margin call and you can do this by raising cash to be able to pay the lender. Sell a portion of your shares or produce extra cash. If these moves fail, you may provide additional security.
Manage Margin Loan Risks
- Do not borrow beyond the maximum amount. The market can turn sour and it is highly advised to borrow conservatively.
- Do not use your home as security.
- Make sure you have cash for margin calls.
- Make regular repayments. The add-on scheme bloats the loan amount. If you cannot afford regular repayments, pay at least the interest.
Contact Australian Lending Centre to find out more about margin loans.
