Most of us understand how getting a mortgage can help us to purchase a home. We use our personal funds (usually 20% of the purchase price) as a down payment and then obtain a mortgage loan with a bank or financial institution for the remaining 80% of the purchase price. The mortgage rate is based on current interest rate levels – there are fixed rate loans that can be for 10, 15, or 30 years, or you may choose an interest-only loan with a floating rate that can start low and increase if interest rates go up and decrease if interest rates go down.
What Is A Margin Loan?
Buying on margin occurs when an investor buys the home using securities in their investment account as collateral for the loan. They are leveraging the securities that they own to get the cash they need. Like other loans, a margin loan has interest that must be paid.
Your margin loan is based on the value of the assets in your account and margin accounts require that the value of the portfolio is kept at a certain percentage of marginable assets. Typically, investment firms permit loans of up to 50% of the portfolio’s value at the time the loan is originated. Not all stocks qualify to be bought on margin, though. The Fed (Federal Reserve Board) regulates which stocks are marginable. Generally, all domestic bonds and listed company stocks are marginable. The money can be used for almost anything, including bridge financing, which is when a buyer needs money to close on a new home and the current home has not yet been sold.
Cons of Buying on Margin
Markets, especially stocks, fluctuate in value. Because of the leverage, gains and losses will be larger in the account. In the event of a market drop and consequent loss in the value of the securities in the account, if the account drops below a certain percentage, a margin call will be issued. You will then have to increase the amount of collateral in the margin account. This is done by adding cash or more marginable assets to the portfolio. The amount added will have to bring the account value back to the required percentage to maintain the margin loan.
If you do not have additional cash or other marginable assets to add, you will be forced to sell securities in the account to increase the collateral in the margin account. Your investment account custodian has the right to sell securities to bring the account back to the required collateral.
In a falling market, it can be disadvantageous to sell to raise money for a margin call because you are selling at lower prices. To guard against this, it is possible to limit your margin to a small percentage of marginable assets to mitigate potential losses and lessen the chance of a margin call. Because of this, it is best to use margin loans for short term cash needs and then apply for a mortgage when the home closes.
Additionally, since using a margin loan is a method of borrowing money, you will have to pay interest on your loan. The interest charges are applied to your account unless you decide to make payments to pay down the margin.
Benefits of Buying on Margin
Margin loans have some potential tax benefits. A margin loan can be use instead of cashing out of highly appreciated stock for a down payment. This will save on capital gains taxes. In addition, interest on a margin loan is generally tax deductible.
When it comes to deducting interest on your taxes, mortgage interest is fully deductible. Margin interest is only deductible up to the amount of your investment income and you cannot deduct it against your qualified dividends or long-term gains unless you give up the tax benefit on the dividends or gains. Therefore, you might not get the full tax benefit from a margin loan as you would with a mortgage.
To summarize, the pros and cons of each method of borrowing are as follows:
|No closing costs
|Not all securities are marginable
|Better rates than a mortgage
|Rates change as interest rates change
|No qualifying requirements – based on assets in the portfolio
|Downward market fluctuations can cause margin calls
|Can close quickly with a cash offer
|Rates can be fixed for long periods
|Lots of paperwork
|Monthly payments help clients plan
|Verification of income and assets
|Mortgage broker helps with closing and issues
Speak to one of our knowledgeable wealth managers at Wealthspire Advisors to determine the best option for you and your specific situation.
About the Author
Wealthspire Advisors LLC is a registered investment adviser and subsidiary company of NFP Corp.
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This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. © 2022 Wealthspire Advisors