It’s a risky strategy, especially given the volatility of stocks. But there are real benefits, and it might actually be an attractive move for a cautious borrower with a sizable portfolio. The most important thing to remember, however, is that borrowing against investments should never be used to expand or buy a house that’s bigger than you had planned.
First, a quick explanation of how using investments as collateral works: borrowers can ask their brokerage firms or banks to set up either a margin loan or a line of credit backed by securities linked to their investment account. Most companies will specify a minimum account size to complete the transaction. For example, at Raymond James, it’s about $150,000, says Randy Carver, financial advisor at Carver Financial Services in Mentor, Ohio.
Keep in mind that this only applies to certain taxable accounts – retirement accounts like IRAs are prohibited. The asset composition of a portfolio will determine the amount that can be borrowed (it is usually defined as a percentage of the account).
If the account value drops below a certain threshold, there is a margin or maintenance call, where the borrower is responsible for depositing additional money into the account – otherwise the brokerage firm may sell the credentials of the account holder to answer the call.
One of the most attractive features of borrowing against investments right now is that it is relatively inexpensive to do so. Although it can vary depending on factors such as the size of your investment account (the bigger your account, the lower the rate), margin loans are offered at around 3% compared to 5.8% for a 30-year mortgage.
Also, because there is a pre-existing relationship with the bank or brokerage firm and different regulatory guidelines, there is usually no real underwriting, which makes the process much faster and easier than getting one. a mortgage loan.
Another advantage is especially relevant now – you don’t need to sell holdings to raise money. Investors who need to do this to make an all-cash offer are likely selling stocks that are down from their all-time high last year, but are still up from when they bought them, which meaning they would be subject to substantial capital gains taxes. . And they would lock in those losses, rather than give those investments time to recover.
Despite these advantages, the greatest danger is of course that the market collapses and you are forced to find extra money, or be at the mercy of the brokerage firm selling everything necessary to get out. equal.
And remember, although the rates on margin loans or equity-backed lines of credit are lower than a 30-year mortgage right now, they’re usually variable rates, which means they will fluctuate with the market.
That’s why the smartest game is to use an investment portfolio as a means to an end, effectively a bridge between selling one home and buying another. And then, after the home sale is complete, pay off the margin loan or equity-backed line of credit and take out a more traditional mortgage.
Nevertheless, given the uncertain economic environment, you will want to be cautious. Companies generally allow borrowers to draw up to 50% of the market value of their account, but sticking to 30% will give you more leeway to play it safe. Likewise, if you plan to sell your home to pay off the margin loan, be realistic about the selling price of your home if the market continues to cool.
Jim Miller, a certified financial planner in Chapel Hill, North Carolina, suggests margin loan holders check rates quarterly — once the rate on a fixed mortgage becomes comparable to the margin loan , It’s time to change. In the meantime, make sure you have a budget in place to pay it back, Miller says.
If you are borrowing from your investment portfolio, remember that the interest you pay for a margin loan is generally not fully tax deductible. You can only deduct this interest from the investment income you earn. With a traditional mortgage, you can deduct all loan interest up to $750,000 if you itemize your deductions.
Margin lending has a bad reputation for getting unwary borrowers in hot water. But if used carefully, they are a smart way for some buyers to become all cash buyers, at least temporarily.
More other writers at Bloomberg Opinion:
Worry about the housing market is only growing: John Authors
Homebuilders hold firm in a cooling market: Conor Sen
Does flipping houses in a bubble create problems? : Chris Bryant
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.
More stories like this are available at bloomberg.com/opinion