Investment debt: why our love affair with borrowing has waned

Share and property investors have long used borrowed money to grow their portfolios, but the strategy has become a lot tougher.

Borrowing to invest has lost its lustre as rising interest rates make it uncomfortably expensive to try to get richer using other people’s money.

The latest Reserve Bank figures show margin lending accounts have dropped by two-thirds in the past 15 years – falling steadily since the global financial crisis, from almost 250,000 in June 2008 to 84,000 in June 2023.

And more broadly for borrowers, the returns required to make investment loans worthwhile have surged amid big rises in interest rates in the past 18 months, impacting both property and sharemarket investors.

The RBA figures show total margin lending in Australia today is about $13.8bn, down from $41.5bn just before the financial crisis hit in 2008.

Interest payable on many margin loans today is about 9 per cent annually, well above the income that shares are likely to pay through dividends. Before May 2022 margin loan interest was around 5 per cent, and the tax deductibility of interest costs made the numbers stack up.

Rising interest rates have caused pain for investors as well as home buyers.

Cheaper borrowing strategies such as home equity loans, and other options that deliver leverage, are also attracting investors’ attention and money.

Baker Young managed portfolio analyst Toby Grimm said margin loan interest was much more expensive than mortgages, and “tapping the equity in your home is considerably cheaper and less exposed to risk”.

“And fluctuating share prices do not affect your loan,” he said.

But remember that if borrowing against your home to invest, “you are risking your home if you can’t pay the mortgage.”

The “scars of the GFC” had turned people off margin lending, where share prices plunged quickly, forcing margin loan selling, forcing prices lower still.

For investment loans to work property, financial returns had to be “greater than your cost of funding”, Mr Grimm said.

“But it’s different for different investors because of its tax deductibility,” he said.

People can negatively gear into shares just as they do with residential real estate, and investors on a higher marginal tax rate get a bigger tax deduction.

“Over the long term, as long as you can meet the repayments, there is historical evidence to suggest it should be a successful strategy,” Mr Grimm said.

“Historically a 10 per cent return on the market is greater than average funding costs.”

Investors who used borrowed money should aim to diversify their assets, Mr Grimm said.

Property investors are also feeling the pain of rising interest rates and tougher lending rules, and new loan commitments for investment housing have plunged about 30 per cent in the past year in NSW, Victoria and Queensland.

Author, property investor and university lecturer Peter Koulizos said high home prices and interest rates were prompting property investors to look towards cheaper markets such as Perth.

“You have to jump so many hurdles these days to borrow money,” he said. “It started in 2017 when banks charged investors higher interest rates and also demanded a bigger deposit.”

Fewer investment properties were pushing rents higher, Mr Koulizos said, but noted that leverage remained “one of the wonderful things about investing”.

Australians could borrow bigger amounts than most other countries, he said, but despite home values doubling in just over a decade “there are less people borrowing, especially for investment, and that’s why there are less rental properties around”.

Midsec Financial Advisors managing director Nick Loxton said lacklustre growth in the global economy had tempered expected returns, so cheaper funding was required to “achieve a reasonable return for the risk”.

An investment’s risk premium, built on top higher funding costs following 4 percentage points of RBA rate rises since May 2022, means much higher returns are required to break even.

“I would have thought a premium of 5 to 6 per cent above the source of funding and allowing for tax would be appropriate,” Mr Loxton said.

It’s a key reason why securing loans against property has grown in popularity.

Investment debt can badly sting people who are unprepared.

“Using bricks and mortar as security is not only a cheaper option, but the bank manager doesn’t ring you and suggest you stump up cash or sell by 2pm that afternoon,” Mr Loxton said.

“Less chance of being a forced seller in down markets, and you can manage the situation over time if required.:

IG market analyst Tony Sycamore said the appeal of margin loans had been dented by the 5 per cent returns people could currently get from cash in the bank.

There were now many more options available to investors wanted to use leverage, including ETFs and CFDs, he said.

“Going back 20 years, if you wanted leverage into the share market you used to have to do it through margin loans … but I think it’s gone out of fashion. People who had margin loans got hurt during the GFC.”