What is a margin loan?
A margin loan is a type of loan offered to investors by brokerage firms in order to make investments by using their broker’s money. The loans are secured by the investment securities that are held in the investor’s account at the same brokerage firm. Margin loans are similar to revolving credit lines because you pay them back on your own time or at the time that you sell your securities.
How a margin loanworks
Margin lending is when you borrow against the value of the securities that you have in your account. It is an interest-bearing loan that can open up access to funds for investment and for other purposes, and your loan to value ratio is important.
Each lender is allowed to define which investments aremarginable as long as they follow specific guidelines under Regulation U. Fundsin retirement accounts or custodial accounts cannot serve as collateral for a margin loan.
Margin interest rates
With marginlending, you must pay back the borrowed money together withinterest. The interest will vary by the amount of the loan and the lender. Theinterest rates can be based on either a market rate index or on the prime rate.The interest is added to the prime rate or market rate index and can vary basedon the size of the investor’s account.
Your interest will depend on the type and value of yoursecurities. You must calculate this interest into your expenses to make surethat you will be able to cover it. The interest rate is typically lower thanthe rates for unsecured personal loans and credit cards.
Margin loans trends
According to FINRA,investors had $178.523 billion in their free credit balances in theirsecurities margin accounts at the end of April 2019. Investors also had$568.433 billion in debt balances in their securities margin accounts.
Margindebt has been trending down over the past year. Since May 2018,margin debt has droppedby 14%. This type of debt tends to fall when the stock market drops.While the debt has been falling, stock market leverage is still currently high.
How to qualify for a loan
Not all investors will qualify to take out a margin loan. Instead, there are several qualifications that must be met.
You need to have a marginaccount for the loan. This is a brokerage account through which thelender can lend cash to the client to purchase securities. There will be aninitial margin requirement, which is the amount of cash that an investor mustplace into the margin account before the broker will agree to margin lending topurchase securities.
You will have a minimum maintenance requirement, which isthe minimum amount of equity that must be kept in a margin account. Thisrequirement varies among brokers. Federal law dictates a minimum maintenancemargin of 25%, but some firms require higher amounts. You can calculate yourmaintenance margin by using the following formula:
Investor’s Equity as Percentage = (Market Value ofSecurities – Borrowed Funds) / Market Value of Securities
You can also use a margincalculator to estimate the maintenance margin. Finally, there willbe a loan to value ratio (LVR) requirement. This is how much you can borrow inproportion to how much you have to invest, and it is set by the lender. Yourequity may be cash or the value of other shares.
Regulation T
Under Regulation T, you are allowed to borrow up to 50% of the purchase price of a stock. The firm has the option to adjust the percentage of margin amounts, and some require more than 50%. The firm also has the ability to limit investors from buying certain investments on the margin.
Accessing the money
If you want to short a stock, invest in commodities andconduct future trades, you are only permitted to do so in a marginaccount. You cannot short a stock or engage in these otheractivities in other types of investment accounts.
Your free margin is the amount of your margin account that is available for new trading. The amount that you have available for buying new securities is your purchasing power, which is normally greater than the cash value.
The Securities and Exchange Commission limits the valueof stocks that an investor can purchase with a margin account at two times theequity in the account. In general, you can borrow 50% of the cost of thestocks.
The Financial Industry Regulatory Authority (FINRA) hasspecial margin requirements for pattern day traders. There is an increasedminimum of $25,000 of equity required and a limit in the account on thepurchasing power at four times the maintenance margin excess as of the close ofbusiness of the previous day for equity securities.
Regulation U
The Federal Reserve Board and self-regulatory organizations(SROs), such as FINRA and the securities exchanges, have rules governing margintrading, but brokerage firms can also set more restrictiverequirements. Regulation U outlines certain requirements for lenders other thansecurities brokers and dealers such as the following:
- Commercial banks
- Savings and loan associations
- Federal savings banks
- Credit unions
- Production credit associations
- Insurance companies
- Companies with stock option plans for employees
When these types of organizations extend credit securedby margin stock, Regulation U requires them to disclose if a loan is a purposeor a non-purpose loan. Regulation U defines non-purpose loans as loans that usean investment portfolio as collateral, but the funds cannot be used to purchasesecurities. These are also known as Securities Backed Line of Credit, or SBLOCs.
Benefits
There are several benefits of a margin loan. It gives access tofunds immediately after approval. You do not have to sell your securities togain access to your money, which gives you liquidity. It also helps todiversify your portfolio and provides you with greater flexibility.
Marginlending also gives you greater purchasing power. With your enhancedpurchasing power, you can potentially increase the return on your investments.
You can repay your loan at any time by depositing moneyor by selling securities. Margin loan rates are typically low. These types ofloans also have low fees also. You will not have to pay annual fees, closingcosts, non-use fees, or other fees that traditional loans might charge.
Margin limitations
There are also some limitations associated with marginlending. You cannot use a margin loan to buy stocks in an individual retirement account,Uniform Gift to Minor Act account, trust account, or another fiduciary account.All of these types of accounts require you to make cash deposits.
If your securities drop in value, a margin loan may increase your losses. If the assets in your account fall below the initial margin requirement for a stock that you purchased, you may get a margin call. This is a demand from your broker that requires you to deposit additional money or securities into your account in order to cover potential losses and your margin debt. A brokerage firm has the right to sell an investor’s securities without providing any notification or has legal remedies if the investor fails to appropriately respond to a margin call.
The marginloan rates may increase during the life of your loan. This can raiseits cost and decrease your purchasing power.
Minimizing risk
To minimize your risk, it is important for you to avoid leveraging all of your accounts in the event that there is a margin call such as when the market drops. You should also look for low margin loan rates and margin loan choices.
Margin loans and taxes
Under the interest tracing rule, your ability to deductthe interest that you paid is determined by how you use the loanproceeds. If you use the money to purchase an investment that generatesinterest, dividends or short-term capital gains, you can deduct it. To claimthe deduction, you must itemize them on your taxes.
Qualified dividends and long-term capital gains are notconsidered investment income. Using a margin loanfor a personal reason or to pay an outstanding tax liability will not qualifyfor the interest deduction, and you cannot deduct the interest if you used theloan to buy tax-advantaged investments. You should consult a tax professionalto learn about the tax implications of your loan.
Margin loans can provide you with more buying power and could help you to increase your return on investment. M1 Borrow provides you with access to money when you need it without the hassle and high costs associated with other types of loans.
The simplest, lowest cost way to borrow money
Offered by M1 Finance, M1 Borrow allows you to borrow up to 40% of your portfolio’s balance and to repay it according to the payment schedule that you choose. You can borrow money at any time at the current low interest rate of 8.75%, or 7.25% for Plus members, which is one of the lowest rates available.
You can enjoy instant access with no additionalpaperwork, no loan officers, no credit check and no denials. It allows you toaccess credit easily and to pay a lower rate of interest than the average ratesfor other types of loans. Your buying power with this type of loan is flexible.You can use the money to fund major purchases, refinance existing debt, addleverage to your portfolio, or pay for life’s emergencies.
Instant access to money with M1 Borrow
When your eligible accounts exceed a balance of $2,000, you will be enrolled automatically. This means that you will be given a credit line that you can access instantly. You are not required to borrow from your credit line, and interest will only be charged on the amount that you borrow. When you borrow money, you can choose whether you want to keep it in your M1 account or to move it to your bank account.
The line of credit has a variable interest rate that tracks the federal funds’ interest rate and is currently 8.75% or 7.25% for Plus members. You can deduct the amount that you spend on interest from your investment income on your taxes, and it is deductible in most cases. The tax-deductibility can make the cost of borrowing money even lower.
Interest is assessed on the amount that you have borrowedat the end of the month. If you have a cash balance in your account, theinterest charges will be deducted from it. If you do not have a cash balance,the interest charges will be added to your debt balance. To repay your loan,there will not be a set payment schedule. You can determine how to pay and whento pay unless a margin call is issued to you.
Investing with M1 Finance
M1 Finance offers an online investment platform and amobile investing app that combine important financial and investing principlestogether with smart technology. You can trust M1 Finance because it offers youa simple, low-cost way to borrow money.
You can use the proceeds to pay down your expensive debt.M1 Borrow has greater tax deductibility than most HELOCs. You can instantlyaccess your line of credit without having to undergo a credit check, fill outadditional paperwork, or deal with a loan officer, and there are no denials.You can borrow money whenever you want at one of the lowest interest rates onthe market and borrow on your own terms.
Take control of your finances with M1
When you open your account today, you can choose from a large variety of portfolios that have been created by financial experts. These portfolios have been tailored to meet different levels of risk tolerance, financial objectives, and times to invest. You can also opt to choose your own securities to create a custom portfolio.
With the investment platform, you will enjoy greateraccessibility and be able to make use of the powerful automation tools wheneveryou want. Investing with M1 Finance allows you to avoid paying commissions and managementfees, which helps your money to work even harder.
M1 Finance uses dynamic rebalancing and automatic reinvestment so that your portfolio stays aligned with your goals. M1’s Borrow offers you access to a portfolio line of credit, allowing you to borrow up to 35% of your portfolio and to set your own repayment schedule. This new feature allows M1 investors to instantly access and use credit at one of the lowest rates on the market.
DISCLAIMER: The following risks may be involved in using your margin: 1) You might lose more money than the deposited amount; 2) You may receive a margin call, and; 3) The interest rate is variable and can increase. For more information about the potential risks of margin loans, please review our Margin Disclosure. Access to M1 Borrow is only allowed for margin accounts that have minimum balances of $10,000 or more. It is not available for retirement accounts.
