Aviva Pinto is a CDFA, CDS and Managing Director and Wealth Manager at Wealthspire Advisors.
Most of us understand how getting a mortgage can help us purchase a property. We use our personal funds (usually 20% of the purchase price) as a down payment and then obtain a mortgage from 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 for 10, 15 or 30 years, or you may choose an interest-only loan with a floating rate that can start low and adapt to interest rates. It can increase if interest rates go up and decrease if interest rates go down.
Buying on margin allows an investor to make a down payment or buy a home using securities in their investment account as collateral. They are leveraging the securities that they own to get the cash they need. Using a margin loan is borrowing money. This means interest will be charged monthly to your account until you pay off the loan.
When assets appreciate, you can make payments toward the margin loan. Brokerage firms and custodians will determine the margin loan interest based on the amount of assets you have with them, with larger accounts charged lower rates.
Margin accounts require the value of the portfolio to be kept at a certain percentage of marginable assets. Investment firms generally allow loans of up to 50% of the current value of the portfolio. Not all assets qualify to be bought on margin. The Fed (Federal Reserve Board) regulates which stocks are marginable. Generally, all domestic bonds and listed company stocks are marginable.
Your margin loan amount will be based on the value of the assets in your account. However, markets—especially stocks—fluctuate in value. A market drop may cause a 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. The custodian of your investment account is allowed to sell securities to bring the account back to the minimum amount of collateral required.
If you receive a margin call in a falling market, you may be at a disadvantage. That is because you may be forced to sell at lower prices to bring up the collateral value. To guard against this, I tell clients to limit their margin to a small percentage of marginable assets to guard against 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.
Margin loans have tax benefits for investors. Instead of cashing out of highly appreciated stock for a down payment on a home, a margin loan can act as a bridge loan. This will save on capital gains taxes. In addition, interest on a margin loan is generally tax deductible.
There is a difference between taxes in mortgages and margin loans. Mortgage loans are fully tax deductible, while margin loans are only tax deductible up to the investment income. It cannot be deducted against long-term profits or qualified dividends unless tax benefits for gains or dividends are waived. Therefore, with a margin loan, you won’t get the full tax benefit.
The pros and cons of each method of borrowing are as follows:
• There are no closing costs.
• It has better rates than a mortgage.
• It’s based on the assets in the portfolio so there are no qualifying requirements.
• There’s a limited amount of paperwork.
• It can be closed quickly with a cash offer.
• Not all securities are marginable.
• Rates change as interest rates change.
• Downward market fluctuations can force the selling of assets.
• Rates can be fixed for long periods of time.
• Monthly payments help clients plan accordingly.
• A mortgage broker helps with closing and any issues.
• Mortgages are fully tax deductible.
• They involve lots of paperwork.
• Verification of income and assets is required.
• An appraisal will also be required.
• Closing costs.
Work with a knowledgeable wealth manager to see which is the best option for you and your specific situation.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.