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Margin Loans margin loans - getting too expensive

Discussion in 'Finance & Banking' started by dkmc, 27th Oct, 2007.

  1. dkmc

    dkmc Well-Known Member

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    Ive been thinking of whether to bother with a margin loan or not.
    Im factoring in 2 -3 interest rate rises too over the next 12 months

    that would put the ML rate at around 10%

    I dont think I can justify such a high rate, with long term averages of return being between 10-14%


    If I could go back in time 3 yrs - Id margin to the hilt on top of LOC - as many of you have done.
    However 10% seems to be the signal to get out

    What is everyone else doing
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Depends on what the markets do ... another year of 20%+ returns makes it easy to justify, even at 100% leverage and 10% rates.
     
  3. Insight

    Insight Brisbane Buyers Agent

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    Very good point!

    And that's assuming you can capture the 50 year ASX returns of 12-13%, remembering that most funds can't match or beat that, and most individual traders as well.
     
  4. dkmc

    dkmc Well-Known Member

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    no one can predict that though. You can only say its easy to justify only after the market has gone up 20% - retrospectively.
    When you come down to it - it is just guessing
    though you may argue educated guesses

    You will eventually get it wrong
    and and if you are leveraged to the max it will hit HARD

    I wouldnt model based on a hope it will go up 20% unless you have warren buffett skills
     
  5. FrankGrimes

    FrankGrimes Well-Known Member

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    Don't ignore tax benefits of borrowing either. Even if you're paying 10% chances are you getting some of this back in tax.. Depending on your marginal tax rate of course. This shouldn't be overlooked.
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Bit of a furphy really ... you only get a deduction because it is a cost ... thus it is losing you money, and you get a small portion of that loss back from the tax-man.

    You are still better off making a profit and paying tax on it than you are paying more in expenses and saving tax.
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    And you can't say that it won't ... remember why our interest rates are high (although historically, they are still quite low!) ... our economy is booming and prices are rising. P/E ratios are still reasonable and company profits are rising.

    Yes, eventually the booming economy will undo itself as costs get out of control and profits drop, that's just part of the cycle ... but I don't think we're quite there yet.

    Yes, care is required - but I don't think it's time to liquidate just yet.
     
  8. Glebe

    Glebe Well-Known Member

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    In May next year check the fixed rate for pre-paying for 12 months.

    Much cheaper than 10%, more like 8%. Suncorp came out with really cheap rates previously, they'll probably do it again.
     
  9. FrankGrimes

    FrankGrimes Well-Known Member

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    I might be missing something.. So please correct me if I'm wrong with my figures

    Lets say, I've invested in well-known LIC as an example..

    Dividend is always 100% franked. So at my tax rate (30%) the effective tax rate on marginal dividend income = 0%

    Therefore ALL interest paid on the margin loan is FULLY deductible against my income at my marginal tax rate or 30% of my interest bill is refunded.

    Please correct me if I'm wrong..
     
    Last edited by a moderator: 28th Oct, 2007
  10. voigtstr

    voigtstr Well-Known Member

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    if you're gearing at 50% though, then your only paying 10% interest on half your investment. Your total return is therefore (based on your figures) 5-9%. There are funds out there doing better than 10-14% long term as well.
     
  11. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    It's no different to property.

    My point was that there are no "tax benefits" in borrowing by itself ... interest is just another cost which you can claim as a valid deduction ... you are not in a better position financially just from borrowing money and claiming the deduction - indeed you are worse off overall, the tax deduction merely reduces the overall loss.

    The benefit comes from the gearing magnifying your returns with an assumption that the returns you get are higher than those after-tax borrowing costs.

    If you aren't making money on the deal, then you are still worse off, no matter what tax refund you get.
     
  12. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Based on the original post, I'm thinking he was planning on drawing money out of an existing LOC to fund the initial capital into the margin loan ... this makes it effectively 100% gearing.
     
  13. FrankGrimes

    FrankGrimes Well-Known Member

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    I've updated my post to include an example of what I mean.. My interest is fully deductible and the fund makes a good profit.

    You are very dismissive.. But I should have included my example in my first post. So my apologies.

    I'm not making a loss, otherwise I simply wouldn't be doing it. So back to my original point is that even if margin loans hit say 10% I'm paying less. Now people need to do their own research as everyone has different tax rates and everyone has money in different funds which may not be as tax effective..

    But the point should still be made!

     
  14. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Yes, but you still aren't getting any tax benefit from the borrowing ... you pay $X interest and you get something like 30% * $X back in deduction (assuming 30% tax bracket) ... meaning you are still 70% worse off after borrowing costs.
     
  15. dkmc

    dkmc Well-Known Member

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    thats right

    I think atm its safer not to enter into margin loans knowing that it is highly likely that rate rises are coming - ie not much buffer. Fine if you have them already. Using seed captial from a LOC at 7.3% seems like the best option.

    If the market had a big fall - id be comfortable using a margin loan - and id probably save this option as funds available when the market drops a lot

    Imagine its 87 - market drops 40% - you get a margin loan 50% LVR and hold on through the recovery- you'd make a lot of money

    It pays to be cautious
     
  16. DaveA

    DaveA Well-Known Member

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    you only have to look back 3 months to see this...

    most funds dropped 20%, if you got in on that day you now would of made 20%.. pretty good return

    however timing was the issue in the last one, using margin loans you would of struggled to get the right day on the last correction.......
     
  17. handyandy

    handyandy Well-Known Member

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    I think I see where you are heading.

    The 10% loan allows you to invest $100k this pays 15% or $15K with a full (wishful thinking) 30% imputation thus there is $5k in imputations.

    You pay the interest on the loan of $10k and you are left with income in the bank account of $5k and still an imputation credit of $5k.


    If you were on 30% flat tax rate (after all tax rates are calculated) then the tax on the $5k income is $1,500 leaving you with excess imputation credits of $3500.

    I believe the tax department will now reimburse these credits where you have insufficient income to utilize them.

    So then the $10k loan payment has a tax rebate on it of $3500 or conversely reduced the cost of the loan from 10% down to 6.5%.

    Cheers
     
  18. handyandy

    handyandy Well-Known Member

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    Or imagine its 1929 and the market drops (whatever it drops) and takes another 25 years to get back to the pre 1929 level.

    The market did not return to pre-1929 levels until late 1954,[2] and was lower at its July 8, 1932 level than it had been since the 1800s.[3]

    Wall Street Crash of 1929 - Wikipedia, the free encyclopedia

    As you summed up 'It pays to be cautious'

    Cheers
     
  19. Rob G.

    Rob G. Well-Known Member

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    Or people with margin loans on negative geared IPs, capitalising interest.

    Interest rates go up, property values flat, compounding debt from capitalising.

    Margin call - desperate to hang on to propery, they start borrowing on the credit card.

    Bank forecloses, sells property for a shortfall (but they have insurance).

    Investor left with a CGT liability (on the property sold by the bank), legal costs, bad credit rating and a large credit card debt.

    Costs of a margin call may be much smaller with liquid assets.

    Cheers,

    Rob
     
  20. Rob G.

    Rob G. Well-Known Member

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    Forgot to mention,

    For any interest capitalisers who think they are conservative factoring in a 10% interest rate next year :

    10% calculated daily, compounded monthly = 10.47% effective

    Cheers,

    Rob