Margin lending is when you invest in shares using a loan secured against the shares you purchase. Many Australian financial organisations and stockbroking houses offer margin lending facilities.
Margin lending, in the form of a margin loan, can be used for any type of investment product recognised as suitable security for a margin loan by the bank or financial organisation providing the cash. Typically, a margin lending product enables you to borrow money to invest in a parcel of shares, or in fixed interest securities or even to invest in units in managed funds.
A margin loan works in the following way:
1. You buy assets with borrowed money and those assets are used as security for the loan.
2. In most cases, your borrowing limit will be no more than 70% of the market value of the shareholding that was purchased with the borrowed money. The remaining 30% of the market value of the shares is to insulate the bank or broker lending the money from any dramatic drop in the share price.
3. If the company you’re planning to invest in is considered a high-risk company, or in a high risk sector, then your lender may only lend you 50 per cent of the value of the shares in that company.
4. If the value of the shares that are subject to a margin loan fall below the amount that you borrowed, then you will be asked to pay cash immediately to your lender to cover the gap in value. This payment request is called a margin call.
5. A margin call can be quite devastating if you don’t have the cash and you’re forced to sell some, or all, of the shares in a falling market. The lender may accept other shares as further security for the margin loan.
6. When a share price drops dramatically, as many shares did during the 2008 and 2009 Global Financial Crisis, you will notice a cascading effect with share prices, as share prices fall further due to the forced sale of shareholdings to meet margin calls.
Note: You can also invest in shares using borrowed money by borrowing against your home or accessing the equity in an investment property. By taking out a mortgage against your home or investment property, the shares that you choose to purchase will not be subject to margin calls although your home will be at risk if you’re unable to repay your loan. By accessing equity in a property, you can usually negotiate a lower rate of interest on your loan compared to the much higher rates charged on margin loans.
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