Margin loans in the UK – my experience

The UK has the most sophisticated financial services industry in Europe. And in some respects, one of the most sophisticated in the world. But in one area it clearly lags the USA – the stock market. Whether it comes to the size of the stock market, the % of society who own stocks/shares, or the number of stockbrokers – we in the UK are a long way behind our transatlantic cousins.

In the UK, even the concept of ‘margin loans’ would leave financially savvy stockmarket pundits scratching their head. Perhaps a couple of them – monevator comments readers I’m sure – would cross-reference to the excellent movie ‘Margin Call‘, starring Kevin Spacey, Demi Moore and Jeremy Irons, but that movie’s lack of success in the UK tells you what you need to know about the wider understanding of ‘margin lending’ in the UK.

As regular readers of this blog know, I am a member of that rare and unusual species – a UK user of margin loans. This page is to serve as some form of introduction to the concept for UK/European readers, as well as summarising some of my experiences and linking to further reading.

What is a margin loan?

Loans generally come in two shapes/sizes – secured loans, and unsecured loans. Secured loans – where the lender has some form of collateral – are cheaper, reflecting the lower risk that the lender is exposed to.

Mortgages, i.e. loans secured by homes, are the classic ‘cheap’ loans in the UK – with headline interest rates of around 2% for owner occupiers. As well as the interest charges, various fees apply – arrangement fees, valuation fees, etc, so the total costs expressed as an ‘annual percentage charge (ARPC)’ are typically higher than 3%.

Margin loans are a form of secured lending offered by stockbroking accounts, which give investors a way of borrowing against shares they own. The stockbroker uses the stocks/shares portfolio as security. This is in theory a very low risk form of lending – a bit like a wine merchant offering you credit when you buy wine ‘in bond’ – because the broker can liquidate (no pun intended) the portfolio to settle the debt. Such loans are known as ‘callable’ – the lender can in theory call it in at any time (like overdrafts, in fact).

As a result of being low risk loans from the point of view of the stockbroker, margin loans can be very cheap loans. You can get margin loans in GBP for as little as 0.6% above base rates, i.e. under 1% per year. In the case of a margin loan there may be no additional fees at all, so the ARPC is the same as the headline rate.

The key risk with a margin loan is that the value of your collateral drops to a level where the lender hasn’t got enough cover to protect them from you not repaying the loan. If that happens they will hit you with a ‘margin call’ – i.e. saying you must sell assets in order to reduce their risk. This ‘request’ is in fact often out of your hands – in the extreme case the lender, as your stockbroker, can and will liquidate positions for you – to a level where the loan outstanding is reduced to a level they feel appropriate.

Mortgages are not callable, so lenders have no ability to access your collateral unless you stop meeting your repayment commitments – the borrower is in control of his/her destiny. With margin loans this is different – if markets crash, or your holdings suddenly get clobbered, the lender may foreclose on your collateral with little or no warning. For reference, there are usually different levels of urgency here – e.g. once the loan is say 70% of the collateral you get ‘a polite warning’ and once it is 80% the bank will do what it has to do with no warning.

[UPDATE thanks to Alex P] In the UK, interest charges on margin loans are not tax-deductible for individuals – but they are for Ltd companies. So if you have an investment company/similar, margin loans are even more cost effective.

An additional benefit of margin loans is that they can be in any major currency. If you feel that borrowing money off a stockmarket portfolio is crazy enough risk for you, you won’t fancy doing it in another currency – but if you want to buy some USD securities on margin without selling your GBP holdings, it is super convenient.

How do you get a margin loan?

The process of agreeing a margin loan is very quick. Your bank/broker will only let you use assets in their account as collateral, but that means the process is super quick. The bank doesn’t need much paperwork on your assets because they have them all already.

The interest is charged typically monthly, and is just applied to the cash balance in the account. So your negative cash balance just becomes very slightly bigger each month. If any any point you want to clear it off, you can just liquidate some of your holdings in the account, enough to turn your cash balance positive, and your margin loan is gone. No paperwork is required.

In the case of my private bank, the process of trading on a margined-account is a tiny bit more cumbersome. With a margined account, the trader needs to check with the risk team. That process takes typically an hour or less, and the trade is then confirmed. It isn’t as slick/realtime as online trading is, but it feels barely any more hassle than trading in an un-margined account. Whereas with Interactive Brokers, there is no difference between using a margined account and using an unmargined account.

What can you use a margin loan for?

The typical use for a margin loan is to allow you to buy more stocks/shares (or contracts of difference, or options, or whatever your poison is).

In theory margin works exactly the same way as for buying a property.

Let’s say you put £100k into a stockbroker account. Say you borrow £50k on margin. This means you can invest in £150k of stocks/shares. Your net liquidation value is £100k, but your total assets amount to £150k and your cash position is -£50k. If your assets yield 3%, and your margin loan costs you 1%, it is easy to see how this investment strategy could appeal.

As with property, your risk is amplified – leveraged – by borrowing. In the example above, if your assets fell by 10%, i.e. from £150k to £135k, your net position is now (£135k less £50k=) £85k – i.e. it is down 15%. The more margin, the more risk.

However, as with property, you do not have to use a loan to buy more property. You can ‘equity release’ cash for other purposes – e.g. your next foreign holiday. If you have £100k in your stockbroker account, and £100k of stocks/shares, and your account has margin enabled, you can simply withdraw £10k (or rather more) without blinking an eyelid. At that point, your net liquidation value would be £90k; your assets would remain at £100k, but your cash position would be -£10k.

My biggest use of a margin loan was to buy my Dream Home, as extensively documented on this blog.

Who offers margin loans in the UK?

If you Google ‘UK margin loans’, there is not a long list of providers. You won’t find it mentioned on the comparison sites with meerkats.

In fact, the UK retail stockbrokers generally do NOT offer margin loans. In this respect, the UK is very different from the USA – where most reputable stockbrokers would offer margin. To the best of my knowledge the main UK players Hargreaves Lansdown, AJ Bell, Interactive Investor, Barclays Stockbrokers, etc do not offer margin loans.

The most obvious and notorious providers of leverage are the spreadbetting firms – IG Index and its rivals. However they offer margin in such a way that causes 70-80% of their customers to lose money – hence the FCA warnings they are obliged to show on all their promotions.

The leading player outside the spreadbetting/Forex trading space, so far as I know, is Interactive Brokers – an American broker which does operate in the UK. I use them myself and their rates are notably low. De Giro appears to provide a UK margin lending service (‘Debit Money’) too – albeit somewhat cludgier than IB’s offering.

The other players are the private banks. Barclays Wealth, Coutts, JP Morgan Private Banking all offer margin loans (a.k.a. ‘Investment Backed Lending’, ‘Lombard Loans’, etc) Goldman Sachs probably do – though a few years ago they told me they didn’t offer it to UK clients, but I imagine that has changed. The Swiss private banks would offer it, I assume, though I don’t know anybody who uses it. I don’t know about Alexander Hoare, and the other ‘niche’ private banks but I imagine they at least understand the question ‘do you offer margin lending?’

How much can you borrow via a margin loan?

I don’t know of anybody who allows you to borrow against tax-sheltered accounts i.e. ISAs or SIPPs.

As mentioned above, the spread betting firms allow very high levels of leverage – up to 10x the amount of collateral. This is extremely risky and often goes wrong. I don’t think of these firms as well suited to long term investors and have never got my head around any of them – even though I understand that IG Index’s platform is remarkably good if you can avoid being trapped into excessive levels of leverage.

Normal levels of margin lending depend on the assets you are securing the loan with. In the USA, there is a standard level of risk known as Reg T, which broadly speaking allows you to double your money. In the UK there isn’t anything as standardised.

My UK private bank will advance 70% margin against any discretionary portfolio they manage for you. This suddenly makes discretionary portfolios feel more attractive. With a £1m portfolio, you can borrow up to £700k, very quickly.

For execution only portfolios, the amount of margin available depends on the security. Broadly speaking, for highly liquid securities, you can borrow 70% or more. This applies to FTSE-100 stocks, big ETFs, and quite a bit else. For less liquid UK securities, you can typically borrow 50%. For some securities – particularly overseas ETFs or microcap stocks – there is no margin ability at all. I’m not sure if the same applies to Interactive Brokers but I suspect it does.

The danger/trap here is that if a security sees its trading volume dip, and its liquidity levels fall, it can suddenly become less useful as collateral. I saw this happen when I first set up my margin account – a large position I had in a relatively illiquid stock flipped overnight from ‘marginable at 70%’ to ‘not marginable at all’. My illiquid stock hadn’t fallen much in value, but its trading volume had dried up. If I had been near my borrowing limits, this would have triggered a margin call.

One point to note is that the products that private banks love selling the most – e.g. structured notes – are not marginable at all! Roughly speaking, the less money your bank makes out of you, the more liquid and thus margin-able the holding is. All the more reason to resist those persuasive sales pitches.

How was it for me?

I started off with margin loans, dabbling in a Dividend Growth portfolio with Interactive Brokers. I ran with a very small – approx 5% – level of leverage. I reasoned that the portfolio had 3-5% yield, and rates were 2-3%, and with a 5% level of leverage the dividends would repay the loan in 12-18 months anyway.

Then I found myself using a £2m+ margin loan to buy my Dream Home at the start of 2016. This was primarily to avoid having to liquidate an extensive portfolio, at a point I felt to be a bad time to be selling (and where hindsight shows I was right). This loan required almost 40% leverage against the ~£5m portfolio it was secured against. Had things turned nasty I would have struggled to avoid margin calls – if the portfolio had dropped say 20% in value my loan would have exceeded 50% of the portfolio, which would have been nearing portfolio limits. However, I knew I had a windfall coming a few months later, and I also had some significant sums in other unmargined accounts (e.g. ISAs), so I felt able to manage the risk – and in time a combination of that windfall, and stockmarket gains pulled my leverage down well below 30% in a matter of months.

What I love about margin loans is how easy they are.

I can decide to buy a new stock, and I don’t have to think about how much cash I have – or whether to sell something, and what to sell, and whether I need to wait for the market to open. I can just buy the new stock – however much I want. If I am comfortable with the additional leverage, that is it; if I prefer to ‘settle the debt’ I can do so at my leisure, perhaps with a couple of judicious limit Sell orders taking advantage of any price pops when the time comes.

Alternatively, if I face a sudden call on a significant sum – e.g. a follow on private equity investment – I don’t have to liquidate any assets to meet it. I can just withdraw from my margined account, and send on the money. And likewise if I receive a windfall, I don’t need to decide what to deploy it into – I can just move it into a margined account and know that I am getting at least a reduction in the loan and the interest charge.

For some time now I have been targeting 10-12% leverage. This is somewhat more than the dividend yield – but still low enough that in fact the dividends would naturally pay off the debt in 3-4 years if I didn’t touch the account. I consider this level of leverage to be almost negligible risk.

On the other hand, my portfolio’s assets are now approximately 80:20 equities:bonds. With the recent S&P bull market, all my dividend reinvestments are into bonds. In practice this feels like using borrowed money (at about 2%) to buy bonds (yielding about 1%), which doesn’t feel too smart. But I tell myself that I am borrowing money to have a slightly larger portfolio, and the mix is 80:20. If equities fell, I would be reinvesting cash into them – and expecting the long term return to more than justify the lending.

Could margin loans be right for you?

Most stockmarket savers/investors in the UK will have the vast majority of their funds in their pension or ISAs. For such investors, margin loans are not much use.

For investors who have significant amounts invested in equities outside tax wrappers, margin loans could be worth considering. Whether it is to provide rapid liquidity that avoids crystallising gains, run a modest level of leverage on long term investments, or access cheap debt without needing to mortgage a house, they can provide very useful.

Those investors with significant unwrapped assets have probably considered private banking/wealth management. If you’re one of these people, but you’ve been put off by the high fees / poor value for money, then the only provider I’m aware of in the UK at the moment is Interactive Brokers. If you find more, please let me know in the comments below.