The highs and lows of margin loans
A margin loan lets you borrow money to invest and uses your
shares or managed funds as security. It can help you increase your
returns but it can also magnify your losses.
Margin loans are for dedicated investors who actively monitor
and manage their investments. Many people have suffered financial
ruin when margin loans have gone sour. If you don't fully
understand how margin loans work and the risks involved,
don't take out a margin loan.
How margin loans work
Let's take shares as an example. When you borrow money to buy
shares, the lender takes as security the shares you buy with the
loan. This means the lender can sell the shares to repay the
Because share prices move frequently, you are exposed to the
risk that the shares might fall in value. To gauge the risk of your
loan, lenders use a Loan to Value Ratio (LVR). The LVR is the
amount of your loan divided by the total value of your shares. Most
lenders require you to keep the LVR below a maximum of 70%.
Example of a Loan to Value Ratio
Jane has $10,000 invested in shares and borrows another $5,000
to invest using a margin loan. This gives her a total share
portfolio worth $15,000. Because Jane's loan represents 33% of the
value of her portfolio, she has a Loan to Value Ratio of 33%.
If the value of your investments falls to a point where your
loan exceeds the maximum LVR, you will be required to top up your
investment or repay some of the loan. This is known as a 'margin
In order to meet a margin call and bring the LVR back to an
acceptable level, you will have to do one of these things:
- Find extra cash to pay the lender
- Sell part of your investment to raise cash
- Give the lender additional security (e.g. security over other
The risks of margin loans
Margin loans are very risky. You may:
- Face huge losses if the market falls
- Be forced to sell part of your investment at a low price to
meet a margin call
- Get an unexpected margin call if your lender decides to lower
the maximum LVR for one of your investments
- Not always be contacted by your lender when a margin call is
In extreme circumstances you could also:
- Owe more than your original investment was worth
- Lose your home if you borrow against it for the investment
- Be forced to pay off your loan at short notice if your lender
decides the investment is no longer suitable as security
*As of 1 January 2011, new credit laws require lenders to contact
investors when making a margin call. Read about the new margin lending requirements.
Case study: Nick's fortune dives
Nick took out a margin loan to invest
in shares when the market was up and earned himself some decent
money. But when the market turned sour during the 2008 global
financial crisis, his lender started making margin calls almost
Nick did not have any money to pay his lender - all his cash was
tied up in his investments. He had put up his apartment as security
for the loan and was in danger of losing it if he did not make a
substantial repayment to his lender. To avoid this, Nick was forced
to sell most of his investments at low prices. The sale prices were
so low that he was still left with a substantial debt. With the
stock market recovering slowly, he is not making as much money as
he used to - but his debt continues to grow.
Tips for managing margin loan
The first rule of margin loans is to borrow conservatively.
This means you should borrow much less than the maximum amount the
lender offers you and never mortgage your home to invest in a
Borrow conservatively and never mortgage your home to invest in
a margin loan.
As a starting point, consider borrowing less than half of what
the lender will give you. This is the best way to protect your
investment. The more you borrow, the more you will lose if the
market falls. Conservative borrowing also reduces the risk of being
forced to sell part of your investment when prices are at their
You should also diversify your investment. Choose a diversified
managed fund or a diversified portfolio of shares. Spread your
investments in different industries and/or markets. It would be
less likely for all areas to fall at the same time, so diversifying
your investments better protects them. Read more about diversification.
Pay the interest
Paying the interest on your loan keeps your debt under control.
Most margin loans do not force you to make regular repayments; the
interest can just be added to the loan (known as 'interest
capitalisation'). Making regular repayments can prevent your debt
from increasing each month.
Check your Loan to Value Ratio regularly
Check your loan account regularly because the value of your
investment can change very quickly. As your investment is used to
secure the loan, you should ensure that you can sell the investment
and repay the loan, if market circumstances change.
Have cash or security ready for margin calls
If your lender makes a margin call, you will have to respond
very quickly, usually within 24 hours or less. The responsibility
falls on you to increase the assets securing the loan or reduce the
loan by the time set out in your margin loan agreement.
Shop around for the best loan
Margin loan interest rates and features vary so shop around for
a lender that best suits you. Start by searching online at the
websites of providers to compare different margin loans.
A margin loan can be great when times are good
but if the market falls, you could be left out in the cold with a
huge loan to pay. Think very carefully before taking out a margin
Last updated: 04 Oct 2017