Protected equity loan

Is it a good idea to use a protected equity loan to prepay the interest on the loan and minimise the capital gains tax?

Be careful with these products and know what can go right and what can go wrong. The ASX website says 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," it explains. "Protected equity loans allow you to establish a portfolio of shares, without paying the entire purchase price."

You have to pay interest on the loan and you are told there is no share price risk. Also, 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 ASX website says. "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."

By the way, ask this if you take out such a loan: is there any circumstance where I wouldn't get my money back? Collapse of the bank? Great depression? And is there a blow up clause? This covers extraordinary market or economic events.

Minimum borrowing amounts generally start at $50,000 and the interest rates charged can be fixed, variable or determined by each stock's volatility.

With these you can 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.

I reckon you need an adviser, accountant or a stockbroker to advise you on these.

Read the following before jumping in. The ASX website says: "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."

But note these important points:

* 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.

As you can see, these are tricky and won't suit everyone. They work better in a rising stock market and the time involved can be critical.

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Protected equity loan

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