A share portfolio can boost your serviceability and help you give proof of genuine savings. We tell you how.
If you've invested in shares, your portfolio could be a handy asset when you apply for a home loan. While lenders may not give you full credit for your share income, your portfolio could help improve your borrowing power.
Share portfolios as genuine savings
During the home loan application process, lenders will assess your income, debt and assets, and how they affect your ability to service the loan.
One factor lenders will look for is proof of genuine savings, such as regular deposits into a savings account. However, they will also take into account any shares you have held for at least three months, so holding a share portfolio in your name can certainly increase your borrowing power.
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Share portfolios as a source of income
When assessing your ability to repay your home loan, banks will take your investments into account. However, because shares fluctuate in value, most lenders will only accept up to 80% of your investment income.
Lenders won't look at the total value of your share portfolio when assessing your serviceability. Rather, they'll look at the dividends you receive from your portfolio. Lenders will also accept regular income from managed funds.
Why won’t shares be accepted as part of my deposit?
One thing a share portfolio can't do is serve as part of your deposit. As an example, let’s say you need $100,000 for a home loan deposit and $50,000 of your savings is tied up in shares. Unfortunately, your bank will not accept the shares you own as a deposit.
The deposit for a home loan needs to be in cash, or perhaps held as equity in another property. This allows the lender to limit their exposure to risk. For example, if you defaulted on your loan repayments, the lender would need to not only sell the property in question but also go after your shares in order to recoup its losses.
It’s also important to remember that the value of your share portfolio rises and falls all the time. So while your portfolio might be worth $50,000 now, in 12 months’ time the value could have dropped to $40,000 or even less, which would obviously have a huge impact on the amount you borrow and your ability to service the loan.
What are my options?
One solution to this problem is to sell your shares and use the resulting proceeds to cover your deposit. This is a simple way around the problem and if you sell enough shares to raise at least a 20% deposit, you can avoid the cost of lender’s mortgage insurance (LMI). Just remember to factor the cost of any capital gains tax you have to pay into your calculations.
However, this may not be the most convenient solution for you if the share market is underperforming at the moment or if you view your stocks as long-term investments. If this is the case, you might want to consider the possibility of taking out a margin loan. These loans allow you to borrow money to invest and use the shares you own as security, and could help you raise enough funds for a deposit.
However, margin loans are for experienced investors only and come with plenty of risks attached, so research all your options thoroughly before going down this path.
What are margin loans?
Margin loans are loans designed to allow you to borrow money to invest in shares or managed funds. Your existing share portfolio or managed fund portfolio is used as security for the loan, allowing you to increase the amount of money you invest.
If your investment portfolio increases in value, margin loans let you take advantage of increased returns. However, if the value of your portfolio drops, any losses you incur will be magnified.
Following the significant financial fallout of the GFC, margin loans have been declining in popularity in Australia. Figures from the Reserve Bank of Australia reveal that the number of margin loans in Australia fell from 248,000 in June 2008 to 137,000 in June 2016.
How do margin loans work?
To help you better understand how margin loans work, let’s use shares as an example. If you take out a margin loan to get funds to buy shares, the shares you own will need to be offered as security. So if those shares decline substantially in value, if you are unable to pay off your loan or if you are unable to pay a margin call , the lender has the right to sell your shares to recoup its losses.
Because they are complex financial products that come with a high level of risk attached, margin loans are best suited to experienced investors who closely monitor their investments on a day-to-day basis.
Pros and cons of margin loans
- Access funds. Margin loans can allow you to access the funds you need to take advantage of investment opportunities.
- Achieve your financial goals. With funding from a margin loan, you can invest for a secure and comfortable financial future.
- Bigger returns. With more money to invest, you can take advantage of the potential for higher returns.
- Diversify your portfolio. Margin loans ensure that you have a larger amount of money to invest, and you can use these extra funds to diversify your investment portfolio.
- Tax deductible. Depending on your circumstances, the interest you pay on a margin loan may be tax deductible.
- Potential for losses. When you borrow through a margin loan, you run the risk of incurring substantial losses. In a worst-case scenario, you could even end up owing more than the amount you originally invested.
- Margin calls. Unexpected margin calls can force you to sell your investment at a low price and have the potential to put you into financial difficulty.
- For experienced investors only. Margin loans are best suited to experienced investors only who fully understand the risks involved.