Join our investing community

Margin Loans Margin Loan help required please

Discussion in 'Finance & Banking' started by rumoid, 14th Sep, 2007.

  1. rumoid

    rumoid Member

    Joined:
    6th Sep, 2007
    Posts:
    18
    Location:
    nsw
    Hi Guys

    Im a newbie to the forum so excuse the basic question

    I was thinking about a obtaining a margin loan of say $20K to match my $20K and investing it in either a manged fund or self selected shares...

    Can anyone tell me in layman's terms how the margin loan works?

    Do I pay the principal and the interest in monthyl instalments or is it just the interest?
    If its only the interest and the loan term is only 2 years what happens at the end of this period- do I have to sell the shares to pay the principal back..
    In terms of tax efficiency- am I right in thinking that I can use the interest cost as a set off against my taxable income.

    Thanks for your help in advance.
     
  2. Rob G.

    Rob G. Well-Known Member

    Joined:
    6th Jun, 2007
    Posts:
    717
    Location:
    Melbourne, VIC
    Welcome.

    You can deduct interest expenses incurred in gaining your assessable income.

    The deductibility of interest follows from the use of the funds and not what you use as security.

    Buying shares or units as an investor is deemed to be for gaining your assessable income as distributions, and so the interest is deductible.

    You usually take an interest only loan as it keeps your paperwork simple and maximises deductions as all repayments are deductible. (blended repayments - yuk!)

    You work on the premise that inflation and capital gains make the future principle repayment (non-deductible) less of a burden.

    Often you just refinance as realising investments to pay back principle incurs CGT and the investments may be good ones that you want to keep anyway.

    Don't forget that any up-front loan establishment fees may be deductible over time or even immediately if less than $100, while recurrent admin fees are usually deductible immediately.


    Cheers,

    Rob
     
  3. rumoid

    rumoid Member

    Joined:
    6th Sep, 2007
    Posts:
    18
    Location:
    nsw
    Hi Rob

    Thanks for the speedy response and the info- a great help

    Can you clear up one more thing if possible

    When people talk of capitalising their interest what does this mean exactly?

    Thanks again
     
  4. Rob G.

    Rob G. Well-Known Member

    Joined:
    6th Jun, 2007
    Posts:
    717
    Location:
    Melbourne, VIC
    Capitalising interest is where you do not actually pay the interest when it is due and it is debited to your outstanding balance. So next month this increased balance is used to calculate you new interest amount. (like a credit card or LOC).

    You must check whether you have this facility as part of the loan contract, otherwise non-payment might be a breach for which penalties might not be deductible and worse might cause a recall of the outstanding amount immediately. Either you pay a higher rate for this facility or you have the loan secured against assets that exceed the current balance sufficiently.

    For compound interest to be deductible, you need to take great care. While the courts have recognised compound interest (non)payment to be a deductible expense, you need to show that the reason for not paying was incidental to gaining your assessable income.

    So, if you merely missed a payment because your distributions did not coincide with your outgoings and you were a bit short on cash but are commited to paying eventually then this should be fine. Even if you repeatedly miss payments in an nogoing investment activity it should be OK.

    But, if you skipped a payment because you wanted to pay for a holiday and you were a bit short on cash then the ATO could deem that the occasion of the (compound)interest expense could be for a private use.

    You would really need to see an Accountant with the actual loan product and your investment plan to be totally sure ...

    Cheers,

    Rob
     
  5. cheeyeen

    cheeyeen Member

    Joined:
    4th Sep, 2007
    Posts:
    22
    Location:
    Melbourne, VIC
    Margin loan is very similar to a interest only home loan except that the security is now the shares or units in managed fund instead of the property and the amount you can borrow depends on the shares that you buy. Most lenders will give around 70-75% for blue chips (check the lender's security lists). For example, said CBA's lending ratio is 75%. You bought 1,000AUD of CBA shares. The minimum that you have to put in is 250AUD and borrow 750AUD from the bank. The problem with this is that you have borrowed to the max for what the bank allow you to borrow, and unlike property the shares move every trading day. If CBA share falls 10% and your shares now worth 900AUD, then ur borrowing of 750AUD is now more than 75% of the security you provide to the bank for the loan (750 borrowing/900AUD share value), and the bank doesn't like that. Just like the bank doesn't like it when you borrow more than 80% of your house value and want you to get mortgage insurance to protect themselves. In margin loan, they will give you a call (margin call) to repay some loan to maintain that 75% lending ratio.
    So rather than putting 250AUD in, you can put 500AUD and borrow 500AUD. That way you are only borrow at 50%. If the CBA falls 10%, then your borrowing ratio is still way below 75% (500AUD borrowing / 900AUD CBA shares).
    You can buy 40K worth of shares if you start a margin lending facility with 20K, and intend to borrow 20K from the bank. Fully invested you will be geared at 50%. Whether this is conservative or risky all depends on the type of shares that you buy. Do make sure you check the lending ratio of the shares that you buy. If you are getting ASX50 shares that is probably ok as most of them will allow you to borrow up to 70-75%. But if you get shares outside ASX200 which lending ratio would be around 50% or lower, then you are at risk of margin call. Your first 20K of shares will be bought with your own money (bank won't charge interest), and anything over that will be the loan from the bank and charged interest on. Usually interest is calculated daily and charge monthly for variable rate loans. Normally you only need to pay the interest, and you specify how you want to pay the interest when you open the margin loan, for example by direct debit from ur saving account, or capitalised it where the interest is added to your loan account. There is no fix rule to say whether you need to repay your principal so in theory you can have the loan for years, as long as you borrowing ratio stay within the lending ratio that the bank allows. You can pay down your loan anytime by deposit more money into the loan account, though I think some banks requires you to maintain a minimum borrowing.
     
  6. rumoid

    rumoid Member

    Joined:
    6th Sep, 2007
    Posts:
    18
    Location:
    nsw
    thanks guys a great help