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Margin Loans Margin Load - How long is it worth having it?

Discussion in 'Finance & Banking' started by the_cubanate, 2nd Nov, 2007.

  1. the_cubanate

    the_cubanate New Member

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    Hi, I'm new to this forum. I recently invested in some managed funds, and I'm considering a margin loan. I've read here and there about margin loans. And the concept (and examples provided by banks) sound good.

    But what I don't understand is for how long is it a good idea to have a margin loan. Meaning when (if any timeframe applies in terms of money) is it worth to start paying the loan off so you get to keep the whole value of your investment.

    Hopefully the question makes sense.

    Also, I understand it is possible to write the interest of a magin loan off as capital lost in terms of taxes. Anyone knows of any article on this?

    THanks in advance,
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Most margin loans are basically a revolving line of credit. In theory, you never have to pay them back.

    From an investment point of view, the idea of IO loans (including lines of credit and margin loans) is that you pay the loan off at some point in the future, using tomorrow's dollars (which are worth more than today's due to inflation).

    In other words, a $100,000 loan today will seam like a lot less in 30+ years time due to the effects of inflation!

    The cost of doing so is the interest you pay along the way - so your total returns need to be higher than the interest rates to justify the expense.

    mmm ... I think perhaps you are confusing the term "capitalising interest" with "capital lost" ?

    Margin loan interest is tax deductible as you are making investment returns from that borrowed money (assuming you don't draw down on the margin loan for personal use !!!).

    The cost of interest is deducted from the income you earn from your investments to calculate your net return.

    If you choose to pay the interest using borrowed money, this is called "capitalising interest", but that has nothing to do with capital losses as such.
     
  3. Glebe

    Glebe Well-Known Member

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    How long is it worth having your margin loan for? The answer is dependent on your crystal ball!

    Basically the way I see it, it comes down to this:

    If your interest rate on your margin loan is 'X'
    and the return on that borrowed money is "Ý'
    then so long as Y is greater than X it's worth using borrowed money to invest in a portfolio.

    Example:

    You borrow $100 000 at 7%. Use it to invest in BHP, and BHP makes 10%. You've just made $30 000 using money other than your own.

    Do you use this $30 000 to pay off your margin loan, so that you only owe $70 000 next year?

    Well, no, not if you again believe that BHP will return 10% again next year. An so on and so forth.

    Ultimately so long as interest rates are single digits and sharemarket returns in the future stay double digits noone should be reducing their margin loans. Unfortunately we're not so flash at predicting the future.

    Good luck!
     
  4. archangelsupreme

    archangelsupreme Well-Known Member

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    I get the concept that a Margin Loan is a revolving line of credit....though some loans i've seen designate terms such as 1 year, 3 years, 5 years with different interest rates.

    Let's say i went with 3 years...So does it mean that after my 3 years i have to pay them back the loaned amount as well as interest payments along the way. Can you start paying the principal off sooner? Do they let you?

    But for managed loans, who would go for 1-3 year options anyway when the recommended time you should leave money in there is usually 3 years or higher?
     
  5. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Usually those fixed terms are fixed interest terms ... at the end of the term you either choose a new fixed term, or your loan reverts to the standard variable rate.
     
  6. archangelsupreme

    archangelsupreme Well-Known Member

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    OK Thanks.

    Most margin loans let you start paying the principal off instantly and on a weekly/ fortnightly basis right?
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Like all LOCs, any extra cash you pay into the loan account comes straight off the principal. You can generally redraw that up to your margin limit at any time.

    The nice thing is that you margin limit will automatically increase as the value of your investments increase (assuming you didn't artificially cap your limit at the time of your application).

    Of course the flip side to this is that your limit will also automatically decrease as the value of your investments decrease :eek: ... this can have ramifications if you end up in your buffer zone - means you can't redraw any cash from your margin loan until the LVR drops again (or you sell some investments).
     
  8. samaka

    samaka Well-Known Member

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    ...and to round off the point -this is called a margin call. Or rather when it drops far enough that the lender comes asking for their money.
     
  9. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Yes, to be clear ... there are two important numbers ... your maximum LVR, and your buffer size. If (for example) your entire portfolio is made up of funds/shares which your lender offers 70% LVR on, then your maximum LVR is 70%. You also get a buffer (usually 5% or 10%) above this. For example, if your maximum LVR is 70% and you have a 10% buffer, then you won't face a margin call until your LVR hits 80% (or there abouts ... it can vary depending on how the lender actually calculates things!!).

    The trick to watch out for is that as soon as you hit your maximum LVR (70% in this example), you generally can't redraw any cash from the loan, since you are already in your buffer zone. This can be a trap if you are "parking" cash in your margin loan to get the high effective returns on your savings (better than a savings account) ... if the market drops suddenly and you enter the buffer zone, you won't be able to pull your cash back out until your LVR drops again. This can be quite nasty from a cashflow point of view.
     
  10. the_cubanate

    the_cubanate New Member

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    I think you mean 3000? I'm using simple interest which is completely wrong.
     
  11. Glebe

    Glebe Well-Known Member

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    Ah yeah, too many 0's :eek:

    Point remains the same though
     
  12. the_cubanate

    the_cubanate New Member

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    Yeah, it does. And it is still good business.

    It seems to me that if you make it an one-off operation and wait over a long timespan then the loan becomes spare change compared to the LVR. Makes sense?
     
  13. Glebe

    Glebe Well-Known Member

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    That's the theory! :D