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Investor Education > Margin Lending > Margin calls and how to avoid them

WHAT IS A MARGIN CALL?

A margin call occurs when the actual Loan to Valuation Ratio (LVR) for a loan exceeds the maximum LVR allowed by the lender. Most lenders will have a buffer of 5%-10% - borrowers face a margin call when the maximum gearing ratio and buffer have been breached.

Upon receiving a margin call, borrowers must restore the balance by either depositing cash or additional assets to the loan, or by selling assets. Unfortunately selling assets to meet a margin call and repay a portion of the loan can also mean that you are forced to sell at a time when the value of your investments has fallen. If you fail to meet a margin call, the lender has the right to sell your securities. The lender will generally try to contact you or your adviser to inform you however it is important to actively monitor your account.

How to avoid margin calls
There are a number of ways to minimise the risk of gearing, with arguably the most important rule being to borrow prudently. For example you may choose to borrow only 50% when the maximum gearing ratio is 70%, this provides you with a greater buffer for falling market values before a margin call is triggered.

Additional strategies for minimising risk include:
 

Do not over-commit Borrow what you can comfortably repay.
Diversification Don't rely on a concentrated portfolio, spread your investment risk across asset classes and market sectors.
Long-term investing Think long-term to give your investments sufficient time to generate enough capital growth.
Insurance Obtain salary or income protection insurance to protect against selling your investments at a possible loss if you or your spouse become seriously ill or disabled.
Fixed loans Fix your loan to protect your cash flow in case interest rates rise.
Monitor your investments Evaluate your investment portfolio on an ongoing basis to ensure it is appropriate for your situation and economic climate.
Reinvesting your income Consider reinvesting share dividends and managed fund distributions to reduce your loan commitment.
Make regular interest payments Paying interest on a regular basis reduces the likelihood of the current gearing ratio exceeding the maximum gearing ratio.
Develop a strategy Have a strategy for how you would meet a margin call.

 

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