Why you may want to take another look at margin loans
Margin lending can offer you considerable flexibility to build your investment portfolio, just the way you want it.
A margin loan is a little bit like having an overdraft for investments, says Adrian Hanley, NAB’s General Manager of Self Directed Wealth. It means you have a revolving line of credit – an amount of funds you can use to purchase shares (domestic and international) and other investments whenever it suits you.
Just like an overdraft, a margin loan gives you the flexibility to invest in the latest stock market opportunity, whether you have the spare cash or not. And just like an overdraft, it’s possible to pay down your debt as soon as possible to avoid paying unnecessary interest.
Securing your loan
The big difference is that your margin loan is secured by shares or managed funds, and how much you can borrow will depend on their ‘security value’.
This brings us to a new analogy – a home loan. If you wish to buy a home worth $500,000, you might borrow $400,000 to help pay for it. That’s because the home is the security for your loan and the bank is only prepared to lend you a percentage of the house’s value, in this case 80 per cent or $400,000.
In a similar manner, if you wish to buy $500,000-worth of shares in a blue-chip company, a margin lender may be prepared to lend you 80 per cent of the total amount (or $400,000), based on the security value of your portfolio of shares.
The main difference here is that while the security value of your home is fixed, your margin lender will revalue your shares on a daily basis, to make sure the security value doesn’t fall below the lender’s requirements.
In addition to giving you considerable flexibility, a margin loan can improve your portfolio liquidity and diversity.
“Lots of people are faced with a dilemma when an opportunity presents itself,” Hanley says. “Do I have to sell some of my existing shares to take advantage of this other investment opportunity or can I simply borrow against my existing shares and take advantage of that new opportunity?”
Of course, it can also help you build your exposure to the stock market.
“You can borrow $100,000 against your existing share portfolio and turn a $100,000 portfolio into a $200,000 portfolio,” Hanley explains.
You don’t have to stop at equities, though. The terms of a margin loan allow you to use part of the loan to fund investment activities outside the share market.
There are potential tax benefits as well. Maybe you have shares that have risen in price but you happened to purchase them less than a year ago. Says Hanley: “You might be sitting on quite a nice capital gain but if you sell the shares now, because you’ve held them for less than 12 months, you’re not going to be able to get the capital gains tax concession.”
A margin loan may enable you to delay selling them. And there’s another advantage to consider.
“As an individual, if you borrow funds in Australia,” Hanley explains, “and you’re using those borrowed funds to invest in an asset with the ability to generate assessable income, then you may be able to claim a tax deduction in the same way people do who’ve borrowed funds to purchase an investment property.”
As with all things tax, you need to consult your own adviser, as these comments are general in nature only.
Often it’s the case, however, that people who take out margin loans don’t end up being negatively geared, Hanley says.
“This is because of the healthy yield environment in Australia when it comes to investing in shares. A lot of people who borrow money in Australia have portfolios that are positively geared.”
Mind the gap
Shares don’t always go up and there is a risk that the value of your share portfolio will start to drift downwards instead.
“If that happens, a margin lender will allow you to have a small value deficit, which is called a buffer,” Hanley says. “But if you go below that buffer you can have a margin call. It’s not a default event; it’s a notice from the lender that you have to bring your portfolio back into line.”
You have the choice of injecting additional cash into your loan or increasing your security’s value by including more shares, he says. You can also choose to sell some of your shares.
“Typically customers inject more cash,” Hanley adds.
Room to move
Most people don’t reach that point, however.
“People who take out margin loans in Australia, will typically exercise a level of conservatism,” Hanley says. “So, while they like the idea of increasing their exposure to the share market, they’ll do it in a way that will leave them enough room to absorb any fluctuations or volatility in the share market.”
It may be worth it for a little peace of mind.