Margin loans: What to know before borrowing

M1 Team August 19, 2022
Woman investor checking loan status on tablet in cafe

Just like banks consider your home equity when lending you money, your investment portfolio can act as collateral for borrowing money through margin loans. This type of loan uses the value of marginable securities like stocks, bonds, and exchange-traded funds to give you access to funds. And because you don’t have to sell securities to borrow money, it helps keep your long-term investment goals on track.

Margin borrowing can be a good way to access cash for short-term needs, like buying a car, starting a business, or investing in more securities. Before you get started, it’s important to know what margin loans are, the benefits and risks of margin lending, how margin calls work, and what tax implications to consider.

What are margin loans?

A margin loan is an interest-bearing loan that allows you to borrow against your portfolio. In other words, the loan uses your portfolio as collateral to give you access to cash.

In the same way a bank can give you a loan based on the equity in your home, a brokerage can give you a margin loan based on the investments in your portfolio. Your broker’s rules will determine how much you’re able to borrow, usually expressed as a percentage of the market value of the securities in your portfolio. To be eligible for a margin loan, you must have a margin account. Once you take the loan, you pay the loan amount and interest to your brokerage firm.

With a margin account like M1 Borrow, you can take out a portfolio line of credit of up to 40 percent of your portfolio’s value if you have a balance of at least $2,000. So if you have $200,000 in assets, you can take out a margin loan up to $80,000.

Although your portfolio is used as collateral for margin loans, you can use them for more than buying stocks. Borrow funds for any purpose you choose, like buying a car, paying student loans, or even covering the cost of a wedding.

Learn more about M1 Borrow and current rates >>

How to get a margin loan

To be eligible for a margin loan, you need to have a specified minimum equity in your brokerage margin account to borrow against your portfolio. But not all securities can be used as collateral for a margin loan—they need to be ‘marginable.’

Each brokerage has its own terms for margin accounts and loans, including the list of marginable securities, minimum equity requirement, and the percentage of portfolio value you can borrow. For example, retirement accounts and custodial accounts at M1 are not eligible for margin loans.

Margin borrowing is typically available on the following account types:

  • Individual/Joint taxable brokerage accounts
  • LLC
  • Partnership
  • Trust*

*At M1, trust accounts are eligible for M1 Borrow if you sign the Margin and Short Agreement when opening an M1 Finance Trust account.

Once you’ve taken the loan, you’ll receive a monthly bill for margin interest until you pay back the loan amount. Oftentimes, margin interest rates are lower than a home equity line of credit interest rate because your portfolio acts as margin equity. Brokerage firms aren’t as worried they’ll lose money on the loan balance due to the protection from securities in your account.

Margin interest can be paid each month or added to the margin loan amount. You can pay back your margin loan amount at a set repayment schedule or on your own schedule, as long as your margin account meets the eligible accounts requirements.

Benefits of a margin loan

Margin loans give you more flexibility in terms of repayment compared to fixed-term loans, like personal loans or mortgages. You get immediate access to liquidity, without liquidating your portfolio.

For example, imagine you have $200,000 in an investment portfolio. You want to do a full kitchen remodel (estimated at $50,000). When you consider other borrowing options, rates may vary widely and may be more than you’d like to spend. So, you decide to shift your strategy to margin loans.

You open a margin account and withdraw $50,000 in cash to pay for the renovation. The results are fantastic:

  • You upgrade to the kitchen of your dreams.
  • Your borrowed $50,000 stays invested in your portfolio.
  • You aren’t missing out on potential market returns since you aren’t selling your securities

In other words, you got your new kitchen and you have the potential to make more money by paying for it with a portfolio margin loan. The best part? You financed a purchase without liquidating securities and pushing your long-term investment objectives off track.

Risks of a margin loan

With any financial product, there are risks. The biggest risk in margin loans is a margin call, also called a maintenance margin call.   

The value of the eligible securities in your portfolio can fluctuate based on market value, but the amount you borrow for the margin loan stays the same. So, if the value of your portfolio falls below a certain point, your brokerage can issue a margin call. This will require you to immediately deposit cash into your margin account or add more marginable securities to bring your equity back up to the specified and required level.  

It’s important to keep tabs on your margin loans as they increase your level of risk. Market volatility can make the total value of your portfolio rise or fall. If that value drops below the minimum margin requirements, you’ll have to start depositing cash, purchasing eligible securities, or selling other securities to avoid a margin call. 

This risk why a margin loan is best for short-term borrowing needs, not long-term loans.

What to use margin loans for

As a long-term investor, you likely want to keep your portfolio intact for long-term goals like retirement, college funds, or inheritance. With a margin loan, you can get immediate liquidity to accomplish short-term financial goals without having to sacrifice your investment strategy. 

Starting a business

If you want to start a business but lack enough capital, a margin loan can help you kick it off. Say you have $8,000 in savings and $5,000 in an individual brokerage account, but you need more money to open your business. You could liquidate some of your $5,000 portfolio by selling securities, but you don’t want your investment plan to go off track. Instead of pulling money out of your portfolio, you borrow against it with a margin loan.  

If you use M1 Borrow, you can take up to 40% of your portfolio. In this example, 40% of $5,000 is $2,000. The funds are immediately available for your business, and your investment goals don’t have to change. 

Buying a car

Margin loans could be a good option if you’re interested in buying a car, but don’t want to liquidate major holdings for the down payment. Say you need $5,000 for the down payment on your dream car. If you have $40,000 of assets in your portfolio, you could borrow $5,000 using a margin loan. This would give you the down payment to buy the car and pay back the loan without having to liquidate any assets.

Margin loans tax considerations

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

The interest investors pay on margin loans is often tax deductible. Keep in mind, the deductible amount is typically limited to the margin interest and other income earned from the margin account.

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

Another key tax consideration when using portfolio margin loans is there are no changes (nothing is bought or sold) within the portfolio unless you are not able to satisfy a margin call in which case securities will be sold in your account to cover the margin balance. 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 unrealized gains.

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.

Is a margin loan right for you?

Almost everybody needs to borrow money at times. Major life moves often require funds that aren’t yet readily available in a cash account. When you need money to bridge a short-term gap, it makes sense to borrow in a way that offers:

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

Portfolio lines of credit check all the boxes. They’re cheaper than most other sources of credit, they’re repayable on your schedule, and they require no application or credit check.

Start borrowing against your portfolio with M1 Borrow >>

Disclosures:

M1 and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

All investing involves risk, including the risk of losing the money you invest. Past performance does not guarantee future performance. Using M1 Borrow’s margin account can add to these risks, and you should review our margin account risk disclosure before borrowing. Nothing in this informational site is an offer, solicitation of an offer, or advice to buy or sell any security and you are encouraged to consult your personal investment, legal, or tax advisors. (LINK for ‘margin account risk disclosure’: https://s3.amazonaws.com/m1-production-agreements/documents/Margin_Disclosure.pdf

M1 Borrow available on margin accounts with at least $2,000 invested. Not available for retirement, custodial, or trust accounts. Rates may vary.

M1 Borrow Funds available in minutes in M1 Spend or M1 Invest accounts, available in 1-2 business days in external banks.