Gearing: loan security, gearing level and LVR

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Lenders will usually require security to be offered when issuing a loan for an investment. A gearing ratio and loan to value ratio can then be calculated.

When borrowing for investment purposes, the lender in most cases takes a charge over the asset financed (apart from home gearing), which in the case of default, can be sold to repay the loan. Assets typically offered as loan security for gearing purposes are property, shares or interests in managed funds.

What is the gearing level?

The gearing level is the amount of money borrowed compared to the value of the investment portfolio, expressed as a percentage. For example, if the loan is $20,000 and the portfolio is worth $100,000 then the gearing level is 20 per cent. The gearing level will change as the value of the portfolio changes. For example if the loan stays at $20,000 but the portfolio grows in value to $200,000 the gearing level decreases to 10 per cent.

What is the loan to valuation ratio (LVR)?

The loan to valuation ratio (LVR) is the amount of the loan compared to the value of the investment portfolio bought with it, expressed as a percentage. When borrowing to invest, the lender will impose a maximum LVR.

For example, for a portfolio of Australian shares valued at $100,000 and a maximum LVR set at 70 per cent, the lender will only lend a maximum of $70,000 (subject to the lender’s credit assessment of the borrower). That way, even if the portfolio decreases in value by 30 per cent, the lender will still have adequate security to cover the loan amount.

Next: Understanding margin loans: risks, benefits and unique characteristics

Margin loans are a type of investment loan and have similar risks and benefits as other gearing strategies, however they also have some unique features.
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Contact BT Technical Services for more information

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