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Protected Equity Loans

While borrowing for an investment property is a well-accepted way to grow wealth, borrowing for share purchases is less widely understood, but the benefits are numerous.  Protected Equity Loans are one way for investors to borrow for share investing.  This type of loan allows you to borrow the total value of a share parcel’s purchase price.

Protected equity loans allow you to establish a portfolio of shares, without paying the entire purchase price.  While you are liable to pay interest on the loan, there is no share price risk.   You are able to benefit from share price gains along with any dividends that may accrue.  As the arrangement is 100% capital protected, you may see the loans as a form of insurance against downward movements in the share price.

The issuers of Protected Equity Loans, the lenders, will typically lend against a portfolio of shares that you select from around 70 large cap stocks.  Minimum borrowing amounts generally start at $50,000 and the interest rates charged can be fixed, variable or determined by each stock’s volatility. 

One of the potential benefits of these loans is the ability to prepay the deductible interest component, combined with potential franking credits that accrue from the portfolio’s dividends.  This can provide tax benefits for some investors.  Tax management needs to work alongside capital growth.  Investors are advised to discuss with their broker, taxation or financial adviser the tax deductibility of the loan’s interest payments.  

Some lenders in this market have Australian Tax Office product rulings, providing assurance to investors and accountants alike.

The protected equity loan market place is competitive and providers have a range of offerings.  These include; a degree of tradability, allowing investors the choice to sell profitable securities and withdraw any proceeds that exceed the amount of the loan, also the ability to re-acquire the same parcel of securities at a later date.  Some have the option to sell securities and purchase a different type of security.  Some lenders allow borrowers to write call options against shares to generate additional income.

At the loan’s conclusion investors generally have a number of options including; repay the loan by selling the portfolio’s securities and retaining any net profit.  Sell a sufficient number of securities to repay the loan and keep the remaining securities.  Sell any securities that have fallen in value at the original purchase price as full repayment for the part of the loan relating to those securities.  Repay the loan with your own funds and keep all the securities with no further obligation to the lender, or extend the loan term if offered the option.

You do need to be aware of the need for an income stream strong enough to cover the interest payments throughout the life of the loan.  As a guide, current rates for protected equity loans range between 12%-16% pa.  When the loan matures, if the shares are worth less than the loan, the lender takes the shares in full satisfaction of the loan. 

In summary protected equity loans generally feature:

  • An interest only loan with embedded put option to protect invested capital
  • 1-5 year terms with flexibility of interest rates
  • Full participation in any capital gains
  • Shares that fall below the loan amount at maturity are handed back to the lender with no additional liability for the shortfall
  • Investors entitled to all distributions on the securities in the portfolio, including franking credits.

Speaking with your stockbroker, or financial adviser is a good way to learn more about this loan product and determine their suitability.

© All rights reserved 2005. This material is educational and it is not intended to constitute financial advice.

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