021 0229 7560 david@pilgrimfs.com

Margin Lending

Debt is a powerful tool that can be rewarding, but leveraging is dangerous when losses are magnified. It should finance assets with growth potential to repay debt. Margin lending or gearing is buying shares by using collateral, and borrowing to increase returns. It enables investors to capture medium to long-term investment opportunities without the required capital. Although the risk is great, the reward can be significant, and should be undertaken if one has collateral and reserves should the market go in the opposite direction. There are tax, legal and financial outcomes that need to considered, and advice should be sought before undertaking such a venture

The shares are taken as security for the lender to sell them if the loan cannot be repaid. Due to the volatility of share prices, there is the risk that the shares might fall in value. To gauge the risk of the loan, lenders use a Loan to Value Ratio (LVR) which is the amount of the loan divided by the total value of shares. Most lenders require the LVR to be below a maximum of 70%. If the loan exceeds the maximum LVR due to the share price dropping, there will be a margin call to top up or repay some of the loan.

If the value of the shares falls below the required maintenance margin, the difference must be paid to balance the account or risk a margin call. This can be done by injecting more cash to lower the borrowed amount or selling some of the existing shares. If this cannot be done, then the shares will be sold without notice to cover the loan.

When a margin call is made, the LVR needs to be back to the acceptable level, and one of the following can be done:

  • Lodge additional funds
  • Sell part of your investment to raise cash
  • Provide additional security

To avoid a margin call:

  • Do not use all the funds at once, buy more when price drops
  • Chose a lower gearing ratio
  • Diversify rather than be exposed to a particular sector
  • Evaluate portfolio regularly

Risk

  • Substantial loss if the market tumbles
  • Forced sale at a lower price to meet a margin call
  • Lender can lower the maximum LVR
  • Unable to be contacted when a margin call is made
  • Owe more than the original investment
  • Lose home if used as collateral
  • Forced loan repayment if lender decides the security is no longer suitable

 

Managing Margin Loans

  • Do not mortgage home to invest
  • Borrow less than the maximum offered
  • Control debt and pay the interest
  • Make regular repayments to prevent debt compounding

Contact us

David Luke, Financial Advisor
Phone: 021 0229 7560
Email: david@pilgrimfs.com