Understanding a margin loan and how it works
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 loan works
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 are marginable as long as they follow specific guidelines under Regulation U. Funds in retirement accounts or custodial accounts cannot serve as collateral for a margin loan.
Margin interest rates
With margin lending, you must pay back the borrowed money together with interest. The interest will vary by the amount of the loan and the lender. The interest 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 based on the size of the investor’s account.
Your interest will depend on the type and value of your securities. You must calculate this interest into your expenses to make sure that you will be able to cover it. The interest rate is typically lower than the 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 their securities margin accounts at the end of April 2019. Investors also had $568.433 billion in debt balances in their securities margin accounts.
Margin debt has been trending down over the past year. Since May 2018, margin debt has dropped by 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 margin account for the loan. This is a brokerage account through which the lender can lend cash to the client to purchase securities. There will be an initial margin requirement, which is the amount of cash that an investor must place into the margin account before the broker will agree to margin lending to purchase securities.
You will have a minimum maintenance requirement, which is the minimum amount of equity that must be kept in a margin account. This requirement varies among brokers. Federal law dictates a minimum maintenance margin of 25%, but some firms require higher amounts. You can calculate your maintenance margin by using the following formula:
Investor’s Equity as Percentage = (Market Value of Securities – Borrowed Funds) / Market Value of Securities
You can also use a margin calculator to estimate the maintenance margin. Finally, there will be a loan to value ratio (LVR) requirement. This is how much you can borrow in proportion to how much you have to invest, and it is set by the lender. Your equity may be cash or the value of other shares.
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 and conduct future trades, you are only permitted to do so in a margin account. You cannot short a stock or engage in these other activities 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 value of stocks that an investor can purchase with a margin account at two times the equity in the account. In general, you can borrow 50% of the cost of the stocks.
The Financial Industry Regulatory Authority (FINRA) has special margin requirements for pattern day traders. There is an increased minimum of $25,000 of equity required and a limit in the account on the purchasing power at four times the maintenance margin excess as of the close of business of the previous day for equity securities.
The Federal Reserve Board and self-regulatory organizations (SROs), such as FINRA and the securities exchanges, have rules governing margin trading, but brokerage firms can also set more restrictive requirements. Regulation U outlines certain requirements for lenders other than securities 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 secured by margin stock, Regulation U requires them to disclose if a loan is a purpose or a non-purpose loan. Regulation U defines non-purpose loans as loans that use an investment portfolio as collateral, but the funds cannot be used to purchase securities. These are also known as Securities Backed Line of Credit, or SBLOCs.
There are several benefits of a margin loan. It gives access to funds immediately after approval. You do not have to sell your securities to gain access to your money, which gives you liquidity. It also helps to diversify your portfolio and provides you with greater flexibility.
Margin lending also gives you greater purchasing power. With your enhanced purchasing power, you can potentially increase the return on your investments.
You can repay your loan at any time by depositing money or by selling securities. Margin loan rates are typically low. These types of loans also have low fees also. You will not have to pay annual fees, closing costs, non-use fees, or other fees that traditional loans might charge.
There are also some limitations associated with margin lending. 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 margin loan rates may increase during the life of your loan. This can raise its cost and decrease your purchasing power.
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 deduct the interest that you paid is determined by how you use the loan proceeds. If you use the money to purchase an investment that generates interest, dividends or short-term capital gains, you can deduct it. To claim the deduction, you must itemize them on your taxes.
Qualified dividends and long-term capital gains are not considered investment income. Using a margin loan for a personal reason or to pay an outstanding tax liability will not qualify for the interest deduction, and you cannot deduct the interest if you used the loan to buy tax-advantaged investments. You should consult a tax professional to 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 7.25%, or 5.75% for Plus members, which is one of the lowest rates available.
You can enjoy instant access with no additional paperwork, no loan officers, no credit check and no denials. It allows you to access credit easily and to pay a lower rate of interest than the average rates for 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, add leverage to your portfolio, or pay for life’s emergencies.
Instant access to money with M1 Borrow
When your eligible accounts exceed a balance of $10,000, 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 7.25% or 5.75% 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 borrowed at the end of the month. If you have a cash balance in your account, the interest 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 when to pay unless a margin call is issued to you.
Investing with M1 Finance
M1 Finance offers an online investment platform and a mobile investing app that combine important financial and investing principles together with smart technology. You can trust M1 Finance because it offers you a 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 instantly access your line of credit without having to undergo a credit check, fill out additional 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 on the 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 greater accessibility and be able to make use of the powerful automation tools whenever you want. Investing with M1 Finance allows you to avoid paying commissions and management fees, 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.