Portfolio line of credit: Is borrowing against your investments a good idea?
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One of the lesser-known benefits of a brokerage account is what’s called a portfolio line of credit, also known as a margin loan. With a portfolio line of credit your broker will lend you money against the value of your securities portfolio, using your stocks, bonds and funds as collateral for the loan. The larger your portfolio, the larger the amount you can borrow.
Here’s how a portfolio line of credit works and whether you should consider using one.
How a portfolio line of credit works
Many brokers allow their clients to take out a portfolio line of credit using the securities in their account as collateral for the loan. You can borrow against the account and generally use the money for whatever purpose you’d like, potentially even just buying more securities.
Like a regular loan, you’ll pay interest on whatever amount you borrow, but a portfolio line of credit typically charges a variable rate that fluctuates as the prevailing interest rate moves. But unlike a regular loan, you won’t have any sort of preset repayment schedule, so you can pay the loan back as you like or even leave it outstanding indefinitely. Any unpaid balance will continue to accrue interest until it’s paid off completely, as cash comes into the account and reduces it.
The interest rate for a portfolio line of credit also typically varies by your level of assets with the brokerage firm, with lower rates for those with higher account balances. Although interest rates have been rising, lines of credit can still offer some of the lowest rates around.
You’ll be able to access a portfolio line of credit in a taxable account only, so you’re not able to borrow against the value of retirement accounts such as an IRA. (If you want to borrow from your 401(k), you have other options for doing that, though experts don’t recommend it.)
Some other types of regulated non-purpose loans may also allow you to use your securities as collateral, but the proceeds cannot be used for buying more securities. These types of loans tend to be more complex and require more time to access than a typical portfolio line of credit.
With a portfolio line of credit, you won’t undergo a credit check, and you can often have the money immediately or within a few hours. In many cases, you simply transfer the funds from the account to a bank, for example, and you’ve established a margin loan against your account.
Each brokerage sets the minimum amount of equity in the account that must be available in order to borrow. Some firms may require only $10,000, but others may require $25,000 or more.
The brokerage also limits how much you can borrow based on the percentage of your total equity value. A level of 30 percent is typical, but some firms may allow you to borrow 60 percent of your total portfolio value or even more. So, if you have $10,000 in your account and your broker allows borrowing up to 35 percent, you can borrow $3,500.
Watch out for a margin call
However, it’s important to watch how much you borrow. Because you’re borrowing against the value of your account, if your account value drops, then the amount you can borrow falls, too. If you owe more than you’re able to borrow, then the broker will issue what’s known as a margin call. You’ll be forced to add enough cash to the account so that you’re no longer overleveraged.
You can often do this in a couple ways. First, you could just send cash to the account and reduce your outstanding loan. Alternatively, you could sell one of your investments and the cash will reduce your debt balance with the broker. If the value of your account increases, however, you may not have to add more equity into account, but this is a very risky strategy.
Either way, with a margin call you need to find a way to get more equity into the account. If you don’t, the brokerage will sell your investments to get cash into the account and protect itself. In fast-moving markets, the brokerage may not even give you time to add cash before it acts.
What can you use a portfolio line of credit for?
Money borrowed on a portfolio line of credit can be used for many different purposes:
- Funding a home improvement project
- Buying a new car
- Consolidating debt
- Educational expenses
- Business financing
- Buying more securities
A portfolio line of credit can be used as a supplement to traditional borrowing options such as bank loans and credit cards or as an alternative method of financing.
Borrowing against your investments is usually a cheaper way to take out a loan when compared to credit cards or bank loans, since the loan is backed by collateral. But you’ll want to check how much a portfolio line of credit costs at your institution. Some institutions generally have low-cost lines of credit available to clients, including Wealthfront and Interactive Brokers, among others.
Pros and cons of using a portfolio line of credit
While a portfolio line of credit can give you access to cash, it’s not a good idea to use it merely because you have it. Here are the pros and cons of a portfolio line of credit.
- Your investments serve as collateral with your broker or lender, and as the loan is directly tied to your brokerage account, no credit checks are required.
- Interest rates are lower than with other forms of borrowing, and they may even be negotiable based on the total amount of assets invested with the firm.
- It spreads a purchase out over time, while allowing you to keep a larger portion of your investments working for you.
- The money may be available immediately or almost so.
- Any borrowing does not trigger capital gains tax.
- You won’t have a set repayment schedule, and typically you won’t have any minimum payment or early payment penalties.
- You can write off your interest costs as an investment expense on your taxes, if you itemize your expenses.
- These loans can have a high degree of risk: If the value of your portfolio falls below the minimum maintenance dollar requirement, you will need to raise the equity in your account to meet a margin call. You must deposit more money to pay down the loan balance, deposit additional securities or sell securities. If you don’t, your broker may sell investments of their choosing without contacting you.
- The broker may raise the minimum required equity for a line of credit at any time without notifying you in advance.
- Because your assets are with one institution, a loan eliminates your ability to “shop around for the best rate” unless you are willing to leave your current broker.
- The interest rates are variable and can increase at any time, but especially when interest rates are rising.
- If you take out too much money, you run the risk of becoming “overleveraged” by borrowing too large a percentage of your portfolio value.
Is a portfolio line of credit right for you?
Whether a portfolio line of credit is right for you depends on your temperament and finances. You’ll need to consider whether the benefits beat the cost of borrowing and associated risks.
A portfolio line of credit can make a lot of sense if you can control your spending and don’t have a tendency to overleverage your brokerage account. But you could wind up in worse trouble if you don’t repay your borrowings and let them continue to grow to exorbitant levels.
But used smartly, a portfolio line of credit could reduce your overall interest expenses. That’s especially true if you’re running a lot of high-cost credit-card debt, for example. But you want to be sure that any decline in your investments won’t force a margin call, too.
Many money managers recommend clients establish a portfolio line of credit even if they don’t use it, since it is helpful to have multiple borrowing options available. In a pinch you can access credit with few restrictions, and you can have money at the ready as needed.
Finally, it’s worth noting that interest expenses in a brokerage account can be tax-deductible if you’re itemizing your taxes. In theory, you could use a portfolio line of credit to pay off other non-deductible debts and get a tax break for the borrowing against your brokerage account. But you’ll need a temperament that allows you to carefully manage your money to do so.
Alternatives to a portfolio line of credit
If you’re looking for cash, one alternative is a home equity line of credit (HELOC).
Things to consider when contemplating a HELOC include:
- The interest expenses could potentially be deducted from taxes, making it an attractive option for financing home improvements.
- Interest rates are typically lower than those charged by credit cards and personal loans.
- Your house is your collateral, and the loans are considered second mortgages if your home is not paid off.
- If you cannot pay your first and second mortgage, your home could be at risk of foreclosure.
- HELOC applications take time to process because it requires a home appraisal and a review of credit history.
You could also use more traditional loans as an alternative to a portfolio line of credit such as personal loans, car loans or credit cards. And in some cases you can access a loan from your 401(k) or 403(b) employer-sponsored retirement account.
Finally, in the right circumstances, it could even make sense to use a credit card with a balance transfer option, especially if it has a low-cost introductory offer or some money-saving perk.
A portfolio line of credit can make a lot of sense for the right borrower. But you’ll need to use it prudently, since it’s backed by the value of your investment portfolio, which fluctuates daily. But it can offer an easy, lower-cost way to access cash, a valuable feature when you’re in a pinch.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
– Karen Roberts contributed to an earlier version of this article.