How margin loans make your money work harder

M1 Team May 30, 2019
How margin loans make your money work harder

It’s an age-old truism about investing: you worked hard for your money, so it should work hard for you. Instead of sitting in a savings account earning too little to keep up with inflation, it should be invested in markets where it can grow.

And within those investments, it should be arranged to earn the highest returns possible for the risk level you’re comfortable with.

To that end, it’s time to consider the benefits of portfolio margin loans as a way to build wealth.

margin loans, portfolio margin loans

What are portfolio margin loans?

Maybe you’re already familiar with the concept of using a margin loan to buy stocks: when buying on “margin,” the investor borrows money from their brokerage firm to purchase stock. Think of it as a loan from your brokerage that allows you to purchase more stock than you’d normally be able to buy.

To be eligible for this kind of loan, you must have a margin account. Your broker’s rules will determine how much you’re able to borrow (usually expressed as a percentage of your portfolio’s value). Once you’ve taken the loan, you’ll pay interest to your brokerage firm.

With M1 Borrow, we’ve made portfolio margin loans available to any M1 customer who has a brokerage account with a balance of at least $2,000. Instead of limiting you to buying stocks, though, M1 Borrow lets you use the funds for any purpose you choose.

Currently, you can borrow up to 40 percent of your portfolio’s value. So if you have $200,000 of fully paid stock, you can borrow up to $80,000 to help with things like buying a car, paying student loans, or even covering the cost of a wedding.

M1 Borrow rates are generally more favorable than rates for other credit sources. In fact, M1 Borrow rates today are lower than most mortgages, home equity lines of credit, and credit cards – and many car loans, too. As you no doubt know, lower interest rates can save you money over time.

When you combine those low rates with returns from investing your borrowed money, you can actually make money from a loan. Here’s how.

margin loans, portfolio margin loans

How portfolio margin loans make your money work harder

The key to earning money by taking out a loan is that the cost of the loan (what you pay in interest) must be less than what it earns you (that is, the return you make by investing the loan dollars).

Let’s look at an example.

You’ve got $200,000 in an investment portfolio. You want to do a full kitchen remodel (estimated at $50,000), but when you look at home equity loans, you see interest rates are above six percent – more than you’d like to spend. So you decide to shift your strategy a little.

You take out a portfolio margin loan, which you can get at 5.75% through M1 (4.25% rates are available to M1 Plus members; non-members pay 5.75%). You then reinvest the loan money in your portfolio and take out $50,000 in equity to pay for the renovation. The results are fantastic:

  • Your kitchen gets the upgrade you’ve been dreaming of.
  • Your borrowed $50k earns a steady seven percent annual return.
  • You pay just 5.75% interest on the loan, meaning you’re still making money.

In other words, you got your new kitchen AND you made $1,750 by paying for it with a portfolio margin loan. That’s the power of portfolio margin loans: you can finance purchases without pushing your long-term investment objectives off track.

Reducing your tax burden with portfolio margin loans

Another reason margin loans are popular among savvy investors is that they can help reduce your tax burden.

While investors don’t get tax breaks for investment losses in a margin account, the interest they pay on margin loans is often tax deductible. Keep in mind, though, that the deductible amount is typically limited to the interest and other income earned from the account.

That is, the interest you pay can be deducted from investment income that you have received. A tax professional can help you determine the rules for your situation.

Another key tax consideration when using portfolio margin loans: when you take out a loan, there are no changes (nothing is bought or sold) within the portfolio. That’s important because borrowing against stock that has appreciated in value, rather than selling it, means that you won’t pay capital gains taxes on any profits.

If, for example, you have a big holding in Company X shares that have increased in value from $50 to $100 per share, selling the stock results in a profit of $50 per share, which is a taxable capital gain. On the other hand, if you borrow against your portfolio, there are no buy or sell transactions. The assets in the portfolio are merely being used as collateral for the loan, which doesn’t increase your tax burden.

Let’s look at a few more use cases to understand the many ways portfolio margin loans can improve your financial situation by making your money work harder for you.

Sally opens a salon

After months of careful consideration, Sally is making a big life move; she is opening a hair salon in her home. She has been paying booth fees at Beauty Clips for several years but has a solid base of return customers. She’s convinced that she can make better profits by going into business for herself.

While Sally has already remodeled her basement with shelves, mirrors, and drawers, she doesn’t have the reclining salon chairs, hair dryers, and other products she needs to get things underway. Her existing $5,000 in savings isn’t enough. She needs about $800 more.

Sally could liquidate some of her $2,000 M1 portfolio, but that’s money she set aside to help with her 12-year-old daughter’s future education needs. She doesn’t want that plan to go off track and so, instead of pulling money out of her portfolio, she borrows against it.

Forty percent of $2,000 is $800 – exactly the amount Sally needs. She taps into M1 Borrow and the funds are made available for her startup. She now keeps 100 percent of her revenues from business and, with a steady revenue stream, she pays off the M1 Borrow loan in 12 months. Her daughter’s school portfolio never goes off track.

Steve and Lisa buy their dream home

Steve and Lisa found their dream home: a cozy three-bed, two-bath cottage nestled on top of the bluffs overlooking the tranquil waters of Half Moon Bay. At $350,000, it’s a hot property. They know it won’t stay on the market long and they’re ready to pounce.

But there’s one problem: Steve and Lisa want to use the equity from their existing home for the down payment on their new one, but that house hasn’t sold yet.

Steve and Lisa can leverage their $100,000 M1 portfolio to help with the down payment for their dream home. Needing an additional $30,000 to secure the property, they borrow $35,000 against the portfolio (the extra $5,000 in case of unexpected closing expenses).

The plan goes off without a hitch. Two months after closing on the Half Moon Bay cottage, they found a buyer for their old house and, once the funds cleared the bank, they repaid their M1 Borrow loan. After consulting with their tax professional, they were happy to learn that the interest paid on the short-term loan helped to offset taxes owed from interest income on year-end taxes. Hooray!  

Give Carl some credit

Carl was laid off and out of work for six months. During that time, he relied on his credit card for day-to-day living expenses. While his M1 portfolio held $250,000, that was money he’d set aside for retirement. He didn’t want to draw from it (or liquidate any of his stock and pay capital gains taxes on the profits) because he wanted to keep his longer-term portfolio intact.

Instead, Carl used M1 Borrow for a short-term loan to pay off the higher-interest-rate credit card. The $250,000 account served as collateral to borrow up to $87,500. Carl needed just a fraction of that. He requested $4,375 to pay off the credit card in one lump sum. After securing a new job, he then made payments of $500 a month to pay off his loan. After just nine months, he’d paid off the M1 Borrow loan in full.

How will you borrow?

Almost everybody needs to borrow money at times. As we saw above, major life moves often require funds that aren’t yet readily available. And when you need money to bridge a short-term gap, it makes sense to borrow in a way that offers…

  • Flexible repayment terms.
  • An affordable interest rate.
  • The ability to keep other financial plans on track.
  • Minimal hassle to get access to the funds.

Portfolio margin loans check all the boxes here: they’re cheaper than most other sources of credit, they’re repayable on your schedule, and they require no application or credit check. In fact, if you use M1 Borrow, you’ll have access to a portfolio margin loan as soon as your account is funded with at least $2,000.

Interested in learning more? Read all about M1 Borrow.

M1 Finance and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.

Using margin involves risks: you can lose more than you deposit, you are subject to a margin call, and interest rates may change. To learn more about the risks associated with margin loans, please see our Margin Disclosure. M1 Borrow available on margin accounts with a balance of at least $2,000. Does not apply to retirement accounts.