Margin loans are calling borrowers
MARGIN loans are used to invest in shares and managed funds.
They were all the rage prior to the global financial crisis, but plenty of investors were stung by these loans when the sharemarket plunged in 2007/2008.
Ironically, there are more investors using margin loans today than prior to the GFC, but most are taking a much more conservative approach to margin lending.
Three years ago, before the global financial crisis hit, more than 250,000 Australians were using margin loans to invest in the stock market.
The appeal of these loans is they let investors borrow to invest. It’s a strategy known as ‘gearing’ or ‘leverage’ and it’s a way of boosting your returns because you only tip in a small amount of your own cash yet receive 100% of the investment returns.
An added drawcard is the interest on margin loans is normally tax deductible, making it a tax-friendly way to invest.
It was an appealing strategy at a time when the sharemarket was delivering double digit returns.
But a downside of these loans is the lender can make a ‘margin call’ if the underlying shares fall in value past a certain point.
When this happens the lender will contact a borrower demanding a chunk of cash be paid into the loan. If you can’t pay up – often within 24 hours, the lender has the right to sell off some of the shares at a time when the price is low.
When the sharemarket went into freefall in late 2007 and early 2008, thousands of Australians watched as their share portfolio was sold off – the result of being unable to meet margin calls.
It was an experience that taught lenders and investors some valuable lessons. Margin loans are still widely used, but this time around they’re being approached in a far more conservative way.
According to a research group Canstar Cannex, average gearing levels among today’s margin loan investors is 32%, meaning only one dollar out of every three invested comes from a loan.
Having a low level of gearing means the shares can drop substantially in value before you cop a margin call.