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Is margin lending for shares safe?

I’ve heard about people making a lot of money using margin loans in the past, but the share price falls recently have meant many people have come a cropper. Is margin lending for shares safe?

A great question, at the right time. My view is that margin loans can be safe, but they can be dynamite in the hands of uninformed investors and stupid, possibly money hungry advisers.

As even the Australian Securities and Investment Commission (ASIC) warns: “Borrowing to invest can potentially result in higher returns, but it also magnifies the extent of any losses suffered if the value of your investments falls.” That’s why you have to understand how margin lending works before you lock into a loan.

With margin lending products, you borrow money to buy things such as shares, units in an investment fund or even fixed interest products. The idea is that these investments become the security for the loan. It won’t surprise you to learn that you pay interest on margin loan and if the value of the investments falls below a certain level, you have to pay more and these are called margin calls. Typically, you could borrow between 30 to 70 per cent of the value of your investments.

One risk is that your lender legally does not have to contact you when a margin call is triggered. ASIC warns you should know your contract before signing up. A margin call can be met by paying more money to your lender, by selling some shares to get the cash or by offering more security to your lender. You have 24 hours to respond to a margin call and the experts say you should watch your margin loan account like a hawk and you should have cash on the side in the event of a margin call. Big share slumps can result in more margin calls!

If you don’t meet a margin call, the lender can sell your shares. Believe it or not, but some loan agreements allow lenders to change the lending ratio at any time without notice, which can result in a margin call.

ASIC says: “The lender may be under no legal obligation to contact you before selling your investments, and may be entitled to sell any of your investments to meet the terms of your loan agreement.” I think this stinks.

The lender can close your account and ask for repayment in full. A major fall in the stock market can be used to justify this action. As you can see, there are many risks with margin loans.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Thursday, December 17, 2009

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