Thinking of using borrowed money to invest? Margin loans offer one way to do it – but they’re not your average investment tool. Before you jump in, it’s worth understanding how they work, what they cost, and where things can go wrong.

Most investors are familiar with the idea of buying shares using their own money , whether that’s from savings, a bonus, or regular income. But what if you could borrow money to invest, potentially increasing your exposure to the market (and your potential returns) without needing extra cash upfront? That’s the concept behind a margin loan.

A margin loan is a financial tool used by some investors to boost their investment capacity. But like all tools, it comes with both advantages and drawbacks. In this article, we’ll unpack what a margin loan is and how it works. We'll also explore the risks involved, giving you a clearer picture of whether it’s a strategy that aligns with your goals and risk tolerance.

What is a margin loan?

At its core, a margin loan is a type of borrowing that allows you to invest more than you could using just your own money. With a margin loan, an investor borrows money from a broker or lender to buy shares, ETFs, or managed funds. They then use those investments (plus any existing ones) as collateral for the loan.

It’s similar to taking out a mortgage to buy a property , but instead of real estate, you’re buying financial assets.

Most margin loans are offered by brokers or specialist lending institutions. They come with terms that outline how much you can borrow, what kinds of assets are eligible, and what happens if your investments fall in value.

How margin loans work

Setting up the loan

To get started with a margin loan, you’ll need to open a margin lending account with a broker or lender that offers this type of service. The provider will ask you to deposit either cash or existing investments into the account, which serves as the foundation for your borrowing.

They will also conduct a credit assessment, looking at your income, assets, liabilities, and overall financial situation to determine how much you can borrow. Once approved, you’ll be assigned a credit limit, which is the maximum amount you can borrow under the margin loan.

The lender will also provide a list of approved securities (such as ASX-listed shares or managed funds ) that you’re allowed to invest in using the borrowed funds. Each of these investments will be assigned a maximum loan-to-value ratio, or LVR.

Some lenders may also apply a buffer to this LVR to account for normal market fluctuations and reduce the frequency of margin calls – more on these shortly.

Understanding the loan-to-value ratio (LVR)

The LVR is a key part of margin lending. It’s the percentage of your total investment portfolio that’s funded by borrowed money. For example:

• You invest $30,000 of your own money.
• You borrow $20,000 using a margin loan.
• Your total investment portfolio is $50,000.

In this case, your LVR is 40%. Most margin lenders allow LVRs of between 30% and 70%, depending on the riskiness of the assets.

Why does this matter? If your LVR gets too high due to falling asset values or rising loan balances, you might face a margin call.

Investing with borrowed funds

Once the loan is in place, you can start using the borrowed money to purchase approved investments. Your portfolio will consist of a mix of your own funds and the loan, and the value of that portfolio will fluctuate based on market movements.

It's worth noting that margin loans don’t usually restrict your investment choices to just individual shares . As we mentioned earlier, many also allow managed funds and ETFs, which can offer diversification and reduce volatility risk.

How interest and repayments work

How interest is charged

Like any loan, a margin loan comes with interest charges. These can be fixed or variable, and are typically calculated daily and charged monthly. The rates can vary between lenders and depend on the size of the loan and market conditions.

Repayment options

Most lenders allow for interest-only repayments, especially during the early stages of the loan. This means you’re only paying for the cost of borrowing, not reducing the principal.

Some investors choose to capitalise the interest, meaning the interest is added to the loan balance rather than paid immediately. While this can ease short-term cash flow, it increases the overall debt and risk of triggering a margin call.

Others make principal and interest repayments, reducing the size of the loan over time and lowering their exposure.

Tax implications

In many cases, the interest on a margin loan is tax-deductible, provided the borrowed funds are used to produce assessable income (i.e. returns from investments).

However, this is not a one-size-fits-all rule, and tax outcomes depend on individual circumstances. It’s always wise to speak with a qualified tax adviser or accountant before relying on this benefit.

What is a margin call, and what can you do?

No, it isn't just a 2012 film starring disgraced actor Kevin Spacey. A margin call is, in fact, the biggest risk in margin lending, and it can happen suddenly. If the value of your portfolio drops and your LVR exceeds the lender’s maximum, you’ll receive a margin call.

This is essentially a demand from the lender to bring your LVR back within acceptable limits. You can do this by:

• Adding more cash to the account.
• Adding more approved assets (like shares or managed funds).
• Selling some of your investments to repay part of the loan.

If you don’t act quickly, the lender can sell your investments on your behalf, often at market lows, to reduce their risk.

This is why investors using margin loans need to closely monitor market conditions and their LVRs. It’s also why margin lending is best suited to experienced investors with high risk tolerance and the ability to quickly respond to changes.

Learn more in ‘ What is a margin call, and how can it affect investors? ’

The main risks you need to know

Leverage cuts both ways

The major appeal of a margin loan is leverage – the ability to amplify your returns. But leverage cuts both ways. If your investments rise, your profits can be higher. If they fall, your losses can be deeper – and you still owe the borrowed money, plus interest.

Volatility risk

Because the share market is volatile, short-term drops in value can trigger margin calls even if your long-term outlook is solid. This risk is particularly acute during market downturns , when lenders may be less flexible and investors may panic sell .

Emotional pressure

The psychological stress of watching a leveraged portfolio swing in value – knowing you might owe money or need to sell at a loss – can be significant. Margin lending adds complexity and emotional pressure, which can lead to poor investing decisions under stress .

A quick example to illustrate

Let’s say you have $25,000 to invest and borrow another $25,000 via a margin loan. Your total investment is $50,000, and your LVR is 50%.

• If the market rises 10%, your portfolio is now worth $55,000.
  • You’ve made $5,000 in gains.
  • Your return on your $25,000 original investment is 20%.
• If the market drops 10%, your portfolio falls to $45,000.
  • Your net equity is now $20,000 (after subtracting the loan).
  • Your loss is $5,000 – a 20% decline in your own capital.

Now imagine a bigger market drop. If your portfolio drops to $35,000, and your loan is still $25,000, your LVR is 71% – likely triggering a margin call.

Regulation and consumer safeguards

ASIC’s oversight

The Australian Securities and Investments Commission (ASIC) regulates margin lending providers and requires them to provide clear, honest information about the risks. ASIC also requires margin lenders to assess suitability before approving loans.

If you’re interested in learning more, you can check out ASIC’s guidance on margin lending here .

Responsible lending

Lenders are expected to act responsibly and not approve loans that are unsuitable for a borrower’s financial situation. They may require you to acknowledge your understanding of the risks, and in some cases, provide financial statements or obtain independent financial advice.

Are there alternatives to margin loans?

If margin lending feels too risky or complex, there are investing alternatives:

• Saving gradually and investing without borrowing – the simplest and least risky approach.
• Using offset accounts or redraw facilities on existing mortgages (with caution and good planning).
• Using ETFs with built-in leverage (exchange-traded funds that aim to multiply the daily return of a market index, typically by 2x or 3x, using financial derivatives and debt). Though, these also come with risks and require careful consideration.

It’s worth noting that margin loans generally don’t align with Pearler’s long-term investing philosophy, which emphasises consistency, compounding, and low-stress investing over time.

Is a margin loan right for you?

Margin loans can be useful in certain circumstances, but they’re far from simple. While they have the potential to boost returns, they also increase risk, complexity, and emotional pressure.

Understanding how LVRs work, how interest is charged, and what triggers a margin call is crucial. And more importantly, understanding your own risk tolerance , goals, and investing horizon is key to making the right decision.

If you're considering a margin loan, speak to a licensed financial adviser and take the time to understand every aspect, including the risks.

Happy investing!