Margin lending in a few easy questions
In order to have a secure retirement, starting an investment portfolio is crucial. Anyone hoping to become an investor will likely run into margin loans at some point. Having an understanding of some of their basics before venturing further in will be useful.
What are margin loans?
A margin loan is also known as an investment loan. It lets you borrow money in order to invest in assets like managed funds and shares. Just as your mortgage is secured against the actual property you've purchased when you take out a home loan, so your shares or managed funds are used as security for the margin loan. This way, if you fail to repay the loan, the lender has something they can sell to cover the loan.
Why would I borrow to invest?
There are a number of reasons why you might borrow money to invest. If you need a little bit of extra cash to make a particular investment you've got your eye on, a margin loan can help you get there. Additionally, having more capital with which to invest can potentially secure you greater returns, if executed correctly. It can also help you achieve diversification in your portfolio.
What are the risks?
As with anything to do with investment, there are risks involved with margin lending. If your investments perform poorly or if there is a fall in the market, a margin loan can potentially increase your losses. Unexpected margin calls can also force you to sell an asset earlier than you would have liked. Just like borrowing to buy property or investing in super, discussing your situation with an experienced financial planner prior to proceeding will lead to better understanding of the risks and benefits.
What is a margin call?
A margin call occurs when the market value of your investments falls, leading your loan to overtake the maximum loan to value ratio, which is typically around 70 per cent for margin loans. When this happens, you are required to to repay some of the loan to bring the loan back to an acceptable level, which may involve you selling some of your assets, providing additional security or simply paying the lender more money.