A margin loan is a loan that uses shares or managed fund units as security. You start with an existing investment or cash contributions, then borrow to expand your portfolio. Your portfolio is security for your loan, just as a house is security for a home loan.
For example: if you own $3000 worth of shares with a lending ratio of 70%, you could use your margin loan to buy another $7,000 worth of the same shares, creating a $10,000 shareholding.
That was just an example, lending ratio means the percentage of the market value of a security that we are prepared to lend against. Different securities might have different lending ratios and it may vary over time based on the value and liquidity of the security. As a margin loan user, you can borrow between 40% to 90% of the market value of an accepted security.
You can use a margin loan to borrow against and invest in different types of shares or managed funds to build your portfolio. In this way you can diversify your investments across a wider range of industries and companies which helps to reduce risk and smooth out returns when a below-average performance in one sector is balanced by a strong performance in another.
In addition, a Margin loan can increases your purchasing power. This gives you the opportunity to buy more shares that could earn more dividends & capital gains. Also you can draw down from your loan anytime, giving you the flexibility to access cash on hand, when you need it.
By Brian Phelps, Executive Manager, CommSec