What Are Margin Loans?

Discover the benefits and risks of margin loans to make informed investment choices.

Navigating the world of finance can feel overwhelming, especially when terms like "margin loan" are thrown into the mix. Yet, understanding margin loans can be a powerful tool in your financial toolkit. Whether you're a loan applicant weighing your options or a financial advisor guiding clients, grasping the intricacies of margin loans can lead to smarter investment decisions.

In this guide, let's explore what margin loans are, how they work, and their benefits and risks so you can decide whether they're right for you.

A margin loan is a type of financial leverage that allows investors to borrow against the securities they already own. Much like a traditional loan, it enables access to additional funds — only, in this case, your investments serve as collateral. This means you can buy more securities than you could with your cash alone, amplifying your buying power.

The idea is simple yet potent. By borrowing against your portfolio, you can enhance your investment strategy. However, it's crucial to understand the workings and implications fully. It's not just about borrowing; it's about making your investments work harder for you.

Think of a margin loan as a way to unlock the value of your existing investments. Much like using the equity in your home to borrow money, a margin loan lets you borrow against the value of your shares, unit trusts, or managed funds — these act as your collateral.

When you open a margin account, your broker determines how much you can borrow using something called the Loan-to-Value Ratio (LVR), which is the ratio of your loan amount to the total value of your investments. For instance, if your broker allows an LVR of 50% and your portfolio is worth S$20,000, you can borrow up to S$10,000.

Understanding margin loan availability

Your margin loan availability shows how much you can currently borrow or withdraw based on your portfolio’s value. Think of it as your “borrowing buffer.” As your investments gain value, your available margin increases. But if your portfolio falls in value, your borrowing power shrinks, and you could find yourself at risk of a margin call.

A margin call happens when your account’s equity falls below the minimum required level. When that happens, your broker will ask you to top up your account by depositing cash, adding more securities, or selling part of your holdings to bring your LVR back within the safe range.

Because of this, margin loans require active monitoring. Keep a close eye on your investments and your loan balance to avoid being caught off guard by sudden market swings. If you fail to meet a margin call, your broker can sell off your securities, often without asking for permission, to recover the loan amount.

While this might sound daunting, margin loans can still be a powerful tool when used wisely. The key is to understand how much risk you’re taking on, keep your LVR comfortably below the maximum limit, and always have a backup plan in case markets move against you.

The primary allure of a margin loan is leverage. It provides the opportunity to increase your exposure to the market without needing to add fresh funds to your account. This can be especially beneficial if you have a strong conviction about a particular investment but lack the cash to capitalise on it fully. It's like having a secret weapon in your investment arsenal, ready to be deployed when the moment is right.

To see how margin loans work in real life, let’s look at two simple examples, one showing the upside potential and another showing the downside risks.

Example 1: The upside potential

Let’s say you invest S$5,000 of your own money to buy 100 shares of a company priced at S$50 each.

A year later, the share price climbs to S$70.

If you sell, your 100 shares are now worth S$7,000, earning you a S$2,000 profit — a 40% gain on your initial investment.

Now, let’s see what happens if you use a margin loan.

You still invest S$5,000 of your own cash, but borrow another S$5,000 on margin from your broker. That gives you S$10,000 total, letting you buy 200 shares at S$50 each.

A year later, the price hits S$70, so your shares are now worth S$14,000.

After repaying your S$5,000 loan plus S$400 in interest, you’re left with S$8,600. Subtract your initial S$5,000, and your profit jumps to S$3,600 — a 72% return on your own capital.

In short:
✅ Without margin — you gained S$2,000 (40%)
✅ With margin — you gained S$3,600 (72%)

That’s the power of leverage. By borrowing to invest, your gains are amplified when the market moves in your favour.

Example 2: The downside risk

But here’s the flip side — the same leverage that boosts your profits can also magnify your losses.

Let’s take the same example, but this time, the share price drops from S$50 to S$30 over the year.

If you only used your own S$5,000, your 100 shares would now be worth S$3,000, resulting in a S$2,000 loss.

If you had borrowed another S$5,000 on margin, your 200 shares would now be worth S$6,000.

You’d still have to repay the S$5,000 loan, plus S$400 in interest, leaving you with just S$600 of your original S$5,000. That’s a S$4,400 loss, or nearly 90% of your own capital wiped out.

In short:
⚠️ Without margin — you lost S$2,000 (40%)
⚠️ With margin — you lost S$4,400 (88%)

This shows why margin loans can be risky. When markets turn against you, losses stack up quickly, and in some cases, your broker might even issue a margin call, forcing you to top up funds or sell assets to cover the shortfall.

Margin loans can offer several appealing benefits for investors looking to expand their investment potential.

1. More buying power

The biggest advantage of a margin loan is leverage. You can buy more shares or funds than you could with cash alone. This means you can seize opportunities when markets move in your favour and potentially grow your portfolio faster.

2. Flexible access to funds

Once your margin account is set up, you can borrow against your investments almost instantly. This makes it much more convenient than traditional loans, which often involve longer approval processes. You can use the funds to buy additional securities, meet short-term liquidity needs, or take advantage of market dips.