This fifth article in the series on accelerated wealth creation introduces margin lending, which many may have heard of but not know how to use it to create wealth.
Margin Lending is a term you may know but perhaps it feels a little bit foreign or even spooky. Perhaps you’re imagining it’s something different to gearing and home equity, which you’ve seen before. Or maybe you’ve heard that it is risky.
Well, if you’ve understood the gearing and home equity concepts discussed in the past few articles then be confident that you also understand margin lending.
That’s because margin lending IS gearing. The main difference to home equity gearing is the security for the loan. With margin lending the security for the loan is usually direct shares and managed funds. So really margin lending is a different name for essentially the same thing – gearing.
One difference is how much you can borrow against your security. For top quality shares and managed funds you can generally borrow up to 70 percent or even 75 percent of the value of the investments. The more speculative your investment the lower the gearing allowed.
Finding a margin loan is quite easy as many of Australia’s largest lenders also have margin lending products. In fact I know of at least one lender who offers a loan that will accept property, shares and managed funds as security, creating a very flexible loan.
Handy features of margin lending
One handy feature of margin lending is that you don’t need to already own a property or shares to start gearing. You just need a small amount of savings. So that makes it a very accessible way of accelerating your wealth creation.
And that leads to the second handy feature – you can start small. You can start some margin loans with as little as $1,000 in savings. The lender will then offer approximately $2,000 as a loan, enabling you to start with a $3,000 portfolio.
These two handy features mean that this is a very accessible strategy, even for people who have just started their first ever job. Read below for how younger people can use margin lending to buy their first home.
Things to be aware of with margin lending
With margin loans the most important distinction to understand is that of the “margin call”. In the interests of brevity I’ll just say that if a margin call occurs you are required to either repay part of the loan, or add more security to the loan. The purpose is to ensure that you have adequate security to keep the lender feeling comfortable.
From a theoretical perspective a margin call could happen with gearing for property investment. But you hear about them in relation to margin loans because the price of the loan security, shares and managed funds, is published on a daily basis.
Whilst over the long term you expect your investment to rise, in the short-term there may be a dip. During the dip you may experience a margin call.
Even if you have maximised your margin lending your investment needs to decrease by around 10 percent before a margin call. So it is not a show-stopping feature. Plus there are plenty of ways to minimise the likelihood of a margin call.
One other feature to be aware of is that the interest rate on margin loans is often a percentage point higher than a home equity loan. So if you have home equity you may like to consider using that first. Plus, with home equity there is less likelihood of a margin call. But on the flip side, if you sell your house you need to refinance the line of credit too.
Instalment gearing for your first home
Instalment gearing is a regular savings plan partnered with a margin loan. Each time you add some of your savings the lender adds some of their money.
You can start an instalment gearing plan with as little as $1,000 in savings and $100 per month contribution. The lender may then offer an initial $2,000 plus $200 per month.
When you are starting in the work force but not ready to buy your first home for 7 years or so, instalment gearing can be fantastic. Many young people I meet are concerned they will never save a deposit as fast as the property prices rise. Instalment gearing is a way to keep up and even fast-track the saving of your deposit.
Super charge your wealth creation
Now, you may be wondering if you can combine gearing with home equity and a margin loan. Well, yes you can and it is a way to super charge your wealth creation plus diversify your portfolio.
For example you could borrow $100,000 against your home and use that as the security for your margin loan. The margin lender may then offer you another $100,000. This gives you $200,000 to invest, none of which is your own. Plus, since your margin loan is only geared to 50 percent you have possibly given yourself a buffer against margin calls.
This strategy is called double gearing and is riskier than single gearing, as you may expect. So proceed with caution and wisdom before considering it.