What is a Margin Call? Margin Lending 101

Margin Lending – ‘Oh Yeah! I have heard of that, isn’t that where you borrow money to invest in shares and then make money on the shares and pay the loan back after making a profit??’ Not quite!

Margin loans are quite useful for people who can borrow what they can afford to pay back safely.

What is margin lending?

Using a margin loan arrangement, the investor’s portfolio of shares and funds are used as security for the loan. The risk involved is that sometimes the market can drop below the level of security required by the banks and once this process has fallen far enough that the ratio of the loan to the portfolio exceeds the max. st by the lender, it (the bank) will step up and make a margin call.

Loan to valuation ratio (LVR)

The lender/bank will ask for additional funds or assets to reduce the loan size and bring the loan-to-valuation ratio (LVR) back below the maximum. If investors are unable to make the extra loan repayment in cash, they may be forced to sell part of their investment.

Avoid margin calls at all costs

It’s better if investors can avoid margin calls and the risks are reduced if the investor doesn’t borrow up to the maximum LVR in the first place, often up to 70 per cent. Lenders often allow a “buffer” of 5 per cent above the maximum LVR which acts to prevent margin calls when the LVR is only slightly exceeded.

The Australian Consumers’ Association advises investors to ensure they can always be contacted by their lenders. Borrowers have to react quickly to margin calls, usually within 24 hours. If the lender can’t contact them, it will make the decision on their behalf, usually to sell down the portfolio.

Save money on margin lending

1. Shop around for the most competitive loan rate. Suncorp Metway offers good rates and alot of times smaller credit unions such as Bendigo and BOQ can help.
2. Always borrow what you can afford to repay.
3. Make sure the interest you pay does not outweigh the profits you are aiming for with your shares in the long run. No point making $5000 if the loan costs $10,000 to repay.

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