Seeking a Flexible Line of Credit? Consider a Loan from a Margin Account

Did you know that a margin account can provide a convenient way to establish a line of credit for short-term financial flexibility?

Margin accounts allow investors to borrow against securities they already own, freeing up cash to buy stocks with collateral or to use the money for other purposes. These credit lines have flexible repayment options and offer competitive rates, and because they’re backed by the securities that borrowers already own, there’s a lot less paperwork to fill out versus other, more traditional loans.

Used responsibly, a margin account allows investors to increase their buying power, take advantage of opportunistic trades, and potentially magnify investment returns. But it’s important to note that trading on margin involves leverage, which can also magnify investment losses.

Dry Powder, Liquid Cash

TD Ameritrade clients who have $2,000 in equity in an account can apply for margin privileges. Once an account has been approved for borrowing, the account holder can take out loans without needing to fill out other forms or pay additional fees.

Chris Jennings, director of margin product at TD Ameritrade, says access to a margin loan allows investors to take advantage of potential trading opportunities, enhance portfolio diversification, and address funding needs outside of the financial markets. Sometimes in order to raise cash for short-term financing or to buy stocks, investors have to sell favored holdings, which can trigger taxable events and reduce their portfolio positions. A margin loan avoids all that. But of course this adds risk and interest costs.

“With a margin account, you don’t have to have dry powder [cash] on hand if you want to be opportunistic or diversify. If you want to keep the stocks you have, you can use a margin loan to buy without having to sell,” he says. But you don’t have an infinite amount of funds at your disposal with a margin account; you need to have available funds in order to take out the margin loan.

Under Regulation T, investors may borrow up to 50% of the value of a securities purchase with a margin loan, according to Federal Reserve rules.

A Flexible Line of Credit

Looking for flexibility? The money investors tap with margin accounts can be deployed for nontrading purposes. Mark Woodward, senior manager of margin product at TD Ameritrade, says margin loans are tied to the firm’s base lending rate. Depending on the size of an account’s margin balance, the margin rate may be above or below the base rate. Also, a margin account is easier to access than, say, a home equity loan, since there aren’t any application fees and no additional paperwork.

Need a little flexibility in repaying the loan? Not to worry. Margin loans let users repay the money when it’s convenient, as long as the loan amount isn’t greater than the margin maintenance requirement. Of course, until the loan is paid off, margin interest will accrue and be charged monthly. But the interest may be tax deductible (another benefit), so be sure to check with a tax professional.

Magnification

Margin loans may help investors increase their buying power, which in a standard margin account is essentially the cash held in the brokerage account plus the loan value of any marginable securities. Using that leverage may mean greater returns since investors are putting in smaller amounts of their own money. If the investment increases in value, it can magnify the value of the return.

But just as leverage can magnify returns, it can also increase losses. That’s an important risk factor to understand, say Jennings and Woodward. Here’s how leverage works in both scenarios.

An investor who wants to buy $20,000 worth of a marginable stock can invest $10,000 of her own money and supplement the other $10,000 with a margin loan. If the value of the stock position rises to $25,000, the investor can close the position with a net profit of $5,000. After repaying the $10,000 loan, the investor now sits on $15,000, less commissions and interest charges..

On the other hand, if the $20,000 worth of stock falls to $15,000 and the investor closes the position, that’s a net loss of $5,000. The $10,000 loan still needs to be repaid, meaning the total account is now worth $5,000. And if the stock falls even further, the $10,000 loan still needs to be repaid. That means it’s possible for an investor to lose more than the original investment amount.

Jennings and Woodward add that if the total account falls to less than 30% equity, the broker may issue a margin call. This happens when losses in an account exceed a limit set either by the broker or its regulating body. Margin calls must be satisfied in short order either by depositing cash or securities or by selling stock. It’s important to understand that your broker can force the sale of securities or other assets in your account. The firm can also sell your securities or other assets without contacting you. You’re not entitled to a time extension while in a margin call.

By allowing responsible investors to increase their buying power, margin accounts can enhance portfolio diversification, and help some investors be opportunistic. And because margin requires collateral, in some cases, the account can be used as a source of flexible financing.