Access to lending on short notice can be a valuable asset. When we need to borrow money, we often think of traditional lending from a bank. However, one quick source of funds at competitive rates is a margin loan against your investment portfolio. With a margin loan, you put up your personal investment account as collateral. In return, your brokerage firm will loan you up to a certain percentage of the value of your portfolio, usually around 50%. Below are some advantages and disadvantages of this option:
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Advantages
Margin Accounts are easy and quick to set up with little or no costs. All you do is complete a margin loan agreement, and then you are good to go.
Flexibility. A margin loan is essentially a line of credit, meaning you access the loan amount only as you need the funds. You pay interest only on the amount of the outstanding loan, and there is no mandatory repayment schedule.
You can avoid taxes with this option. Typically, if you need to raise cash and have to sell appreciated securities, you will owe capital gains taxes. By using a margin account, you avoid stock sales, and the stocks have an opportunity to continue to grow in value.
Interest paid is based on a competitive rate. You will typically receive a competitive interest rate because the account is collateralized with highly marketable securities; plus, the lender’s margin of risk is minimal. Compare this rate to, say, the interest rate on a credit card (often 18% or more).
Interest is deductible. Interest paid on a margin loan is a deduction against net investment income.
Disadvantages
Margin call. Stocks are volatile, and if the value of your portfolio falls below your margin limit, you will get a margin call. At that time, you must either put more money into your account or sell securities to raise cash to bring your limit back into line.
This is NOT available on retirement accounts. Margin loans are only available on personal accounts.
Interest rates can rise.
The bottom line is margin loans can be a useful tool, particularly for short-term funding needs. However, you need a well-thought-out plan if you decide to borrow using margin lending. Be sure to consult with your financial advisor before using margin loans.
