3 Ways to Borrow Against Your Assets (part 2 , Margin and Securities-based lines of credit )
2. Margin
What it is: Just as a bank can allow you to borrow against the equity in your home, your brokerage firm can lend you money against the value of eligible stocks, bonds, exchange-traded funds, and mutual funds in your portfolio. Margin loans typically require a minimum of $2,000 in cash or marginable securities and generally are limited to 50% of the investments' value. Interest rates vary depending on the amount being borrowed but tend to be lower than unsecured lending options such as credit cards.
When to use it: Funds borrowed on margin are usually used for:
- Additional investments: Active traders may establish a margin account as a way to take advantage of a trading opportunity when they don't have adequate cash on hand. If you use the funds to purchase investments that generate taxable income—including interest, nonqualified dividends, and short-term capital gains—you may be able to deduct the interest paid if you itemize your deductions. However, if the value of your margin account falls below the maintenance requirement—the minimum dollar amount that you must maintain in the margin account once you've tapped the funds—your brokerage will issue a maintenance call, which requires you either to deposit more money or marginable securities or to sell some of the assets held in your account.
- Short-term liquidity needs: As with any line of credit, you can draw from and replenish a margin account for any reason, not just purchasing securities. A margin loan is a ready source of credit that may be used as a short-term loan for any need—and unlike a HELOC, there's no lengthy application process. But I can't stress enough the importance of moderating your borrowing. If you borrow too much and your portfolio's value declines before you repay the money, you could face a hefty maintenance call—or a large tax bill if appreciated securities are sold to meet the maintenance requirement.
P.S. It's important that the assets in your account are diversified. If you're overly concentrated in a particular investment, you could quickly find yourself below the required maintenance threshold if that investment declines considerably.
3. Securities-based lines of credit
What it is: Similar to margin, a securities-based line of credit offered through a bank allows you to borrow against the value of your portfolio, usually at variable interest rates. Assets are pledged as collateral and held in a separate brokerage account at a broker-dealer. Unlike margin, these nonpurpose credit lines may not be used to purchase securities or pay down margin loans, nor can the funds be deposited into any brokerage account. Such lines of credit also tend to require more borrowing than a margin account. For example, a securities-based line of credit for $100,000 may require you to take an initial minimum advance of $70,000 upon establishing the line.
When to use it: Because of the potential large initial advance requirement that may apply, a securities-based line of credit is best for:
- Bridge financing: We typically see a securities-based line of credit used for something that would otherwise be a short-term loan. For example, clients who wish to buy a new home before they've sold their current one have found that this type of credit line can provide a useful bridge between the two transactions.
- Liquidity: When you need quick access to cash but don't want to sell your investments—which can trigger capital gains taxes—a securities-based line of credit could be a solution. Because of the high initial advance requirement, it's best to establish this type of credit line close to when you have an immediate cash need, such as a significant tax bill. Once you take the initial advance, however, you can use the credit line for smaller liquidity needs going forward.
