Finance Dollars & Sense Margin lending: Everything you need to know about borrowing to invest

Margin lending: Everything you need to know about borrowing to invest

investing businessman inflating bar graph
Margin lending is one way to borrow money to invest in shares. Photo: Getty
Twitter Facebook Reddit Pinterest Email

With the sharemarket reaching new highs, many people are looking on from the sidelines and asking themselves should they be involved.

If you only have a little extra cash at hand then borrowing could be a way forward.

There are two ways to borrow money to buy shares.

The first is through a loan against property and the second is through margin lending.

People with a home loan or investment property can use the first method, which involves boosting the size of your loan by the value of the shares you buy.

The security for the loan is the property against which you are borrowing and you simply access more cash by drawing down on your equity.

The second way, margin lending, is where the lender takes security against the shares you buy.

Margin lenders will typically want you to have 30 per cent of the value of the shares you want to buy in cash to give them some comfort amid the vagaries of the market.

If you want to use your home loan, you just need to go to the bank and arrange to increase your mortgage.

This will likely have no effect on your monthly mortgage repayments as the bank already has security over your asset.

However, you will be restricted to borrowing whatever the bank wants to lend – and you will have to keep your loan-to-value ratio below 80 per cent to avoid having to pay lenders mortgage insurance.

Hewison Private Wealth adviser Chris Morcom said the cost of borrowing against your home was much lower than against shares.

“Perhaps half as much as a margin loan will be,” he said.

As this table from Canstar demonstrates, a margin loan will cost you between 4.82 per cent and 6.04 per cent, depending on the terms you choose.

If you pay the bank in advance so you can claim a tax deduction early, you will pay less in interest than if you paid in arrears, which is how you make your mortgage repayments.

In a world of record-low interest rates, home loan rates have fallen to as low as 1.59 per cent, according to RateCity.

Margin lending is a high-risk strategy

At times like this, margin lending looks like a gimme.

You get the profit from all the rise in your portfolio above your interest costs while stumping up as little as 30 per cent of the value of the shares.

But if things go against you the opposite is true.

“Margin lending increases the risk of loss if the market falls, as well as increasing the possibility of gain,” Mr Morcom said.

That doesn’t take away the possibilities, but it means you have to be clear about your objectives and how much risk you can carry.

“I’m quite selective about who I recommend margin lending to,” said Stevie-Jade Turner, an adviser with Tribeca Financial.

If you are a person who chooses high-growth investments and can afford – or are prepared – to take a loss then it could be for you.

But you should also take into account the views of your other half.

“If they’ve got a partner who is a little conservative, and especially if they want to put the loan in both names, then I tend to lean to not doing it,” Ms Turner said.

Another consideration is your tax position.

As alluded to earlier, margin interest is tax deductible because it is a business expense.

But that is going to be much more of a benefit “if you are in a higher marginal tax bracket,” Ms Turner said.

How much to borrow

Given the volatility of the sharemarket, most advisers will advise against taking on a margin loan with a loan-to-value ratio (LVR) above 50 per cent – even if you can get approved for up to 70 per cent.

Remember also that if the market tanks, your LVR could fall below the that crucial 30 per cent threshold, or whatever equity the bank demands you maintain.

In that scenario, you would get an unpleasant ‘margin call’ from the bank demanding that you stump up the difference.

If you don’t have the cash, you will have to sell the shares at a loss and things will get nasty.

Another thing to be aware of is double gearing.

“That’s where you borrow against your home, use the funds to buy some shares, and then get a margin loan on top of that,” said Wayne Leggett, an adviser with Paramount Financial Solutions.

“That makes you 100 per cent geared,” he warned.

A final warning

One final consideration for those still interested: If you buy just one stock, you face a bigger risk than buying a basket of shares or managed funds that would leave you less vulnerable to the volatility of the market.

A quick internet search will show you which lenders are looking for margin business and then you can take it from there.

It is recommended that you talk about your plans with a licensed financial adviser before proceeding.

Your investment time frame is crucial because the sharemarket is volatile.

“If you’re investing for less than five years, a margin loan is just not going to be appropriate,” Mr Morcom said.

“The risk of the market falling and not recovering enough to deliver a profit is just too great.”