One of the lesser-known benefits of an investment account is a so-called 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 line of credit in their portfolio, 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 like, and possibly even just buy more securities.
Like a regular loan, you pay interest on the amount you borrow, but a portfolio loan usually charges a variable interest rate that fluctuates as the prevailing interest rate moves. But unlike a regular loan, you don’t have a preset repayment schedule, so you can repay the loan as you wish or even leave it outstanding indefinitely. Any unpaid balance will continue to accrue interest until it is paid off in full as cash enters the account and it is reduced.
The interest rate for a portfolio loan also typically varies depending on your asset level with the brokerage firm or how much you have borrowed, with lower rates for those with higher account balances. Although interest rates have increased, lines of credit can still offer some of the lowest rates available.
You only have access to portfolio credit in a taxable account, so you can’t borrow against the value of retirement accounts like an IRA. (If you want to borrow from your 401(k), you have other options for doing so, although experts don’t recommend it.)
Some other types of regulated non-target lending may also allow you to use your securities as collateral, but the proceeds cannot be used to purchase more securities. These types of loans are typically more complex and require more time to access than a typical portfolio line of credit.
With a portfolio loan you do not undergo a credit check and you can often access the money immediately or within a few hours. In many cases you simply transfer the money from the account to, for example, a bank and you have placed a margin loan on your account.
Each brokerage sets the minimum amount of equity in the account that must be available in order to borrow. Some businesses may only need $10,000, but others may need $25,000 or more.
The brokerage also limits how much you can borrow based on the percentage of your total stock value. A level of 30 percent is common, but some companies 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.
Beware of a margin call
However, it is important to look at how much you borrow. Because you are borrowing against the value of your account, the amount you can borrow also decreases if the value of your account decreases. If you owe more than you can borrow, the broker will make what is called a margin call. You are forced to add enough cash to the account so that you are no longer in excess debt.
You can often do this in a few ways. First, you can simply send cash to the account and reduce your outstanding loan. Alternatively, you can sell one of your investments and the money will reduce your debt balance with the broker. However, if the value of your account increases, you may not need to consider more equity, but this is a very risky strategy.
Either way, with a margin call you have to find a way to get more equity into the account. If you don’t, the broker will sell your investments to get cash into the account and protect themselves. In fast-moving markets, the brokerage may not even give you time to add money before taking action.
What can you use a portfolio loan for?
Money borrowed on a portfolio line of credit can be used for many different purposes:
- Financing a home improvement project
- Buy a new car
- Consolidating debts
- Educational expenses
- Business financing
- Buy more securities
A portfolio line of credit can be used to supplement traditional lending options such as bank loans and credit cards, or as an alternative financing method.
Borrowing against your investments is usually a cheaper way to take out a loan compared to credit cards or bank loans because the loan is backed by collateral. But you want to know how much a portfolio line of credit costs at your institution. Some institutions generally have low-cost lines of credit available to customers, including Wealthfront and Interactive Brokers, among others.
Pros and cons of using a portfolio line of credit
While a portfolio loan can give you access to cash, it’s not a good idea to use it just because you have it. Here are the pros and cons of a portfolio line of credit.
Plus points
- Your investments serve as collateral with your broker or lender, and since the loan is tied directly to your investment account, no credit checks are required.
- Interest rates are lower than other forms of borrowing, and can even be negotiated based on the total amount of assets invested with the company.
- It spreads a purchase over time while allowing you to put more of your investments to work for you.
- The money may be available immediately or almost.
- Each loan does not incur any capital gains tax.
- You do not have a fixed repayment schedule and there is usually no minimum payment or early payment penalty.
- You can write off your interest costs as investment costs on your taxes, if you itemize your expenses.
Disadvantages
- These loans can carry a high degree of risk: If the value of your portfolio falls below the minimum maintenance dollar requirement, you will need to increase the equity in your account to meet a margin call. You will need to deposit more money to pay off the loan balance, post additional collateral or sell securities. If you don’t, your broker can sell investments of your choice without contacting you.
- The broker may raise the minimum equity requirement for a line of credit at any time without prior notice to you.
- Because your assets are held by one institution, a loan eliminates your ability to “shop around for the best rate” unless you are willing to leave your current broker.
- Interest rates are variable and can increase at any time, but especially if interest rates rise.
- If you withdraw too much money, you risk becoming overleveraged by borrowing too large a percentage of your portfolio value.
Is a portfolio loan something for you?
Whether a portfolio loan is suitable for you depends on your temperament and finances. You should consider whether the benefits outweigh the costs of borrowing and the associated risks.
A portfolio line of credit can make a lot of sense if you can control your expenses and don’t tend to overextend your investment account. But you could find yourself in worse trouble if you don’t pay back your loans and let them grow to exorbitant levels.
But if you use it wisely, a line of credit in your portfolio can lower your overall interest costs. This is especially true if, for example, you have a lot of expensive credit card debt. But you want to be sure that any decline in your investments won’t also force a margin call.
Many money managers recommend that clients set up a line of credit in their portfolio even if they don’t use it, because it’s helpful to have multiple lending options available. In no time, you can access credit with few restrictions and have access to cash when needed.
Finally, it’s worth noting that interest costs on an investment account can be tax deductible if you itemize your taxes. In theory, you could use a line of credit in your portfolio to pay off other non-deductible debts and get a tax break on the loans in your investment account. But for that you need a temperament that allows you to handle your money carefully.
Alternatives to a Portfolio Line of Credit
If you’re looking for cash, an alternative is a Home Equity Line of Credit (HELOC).
Things to consider when considering a HELOC include:
- Interest charges may be tax deductible, making it an attractive option for financing home improvements.
- Interest rates are typically lower than credit cards and personal loans.
- Your house is your collateral and the loans are considered a second mortgage if your house is not paid off.
- If you can’t pay your first and second mortgages, your home is at risk for foreclosure.
- HELOC applications take time to process because they require a home appraisal and credit history review.
You can also use more traditional loans as an alternative to portfolio credit, such as personal loans, car loans or credit cards. And in some cases, you can access a loan through your 401(k) or 403(b) employer-sponsored retirement account.
Finally, under the right circumstances, it can even make sense to use a credit card with a balance transfer option, especially if it has a low-cost introductory offer or a money-saving benefit.
In short
A portfolio line of credit may make sense for the right borrower. But you need to use it wisely because it is backed by the value of your investment portfolio, which fluctuates daily. But it can provide an easy and cheaper way to access cash, a valuable feature if you’re in a pinch.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making any investment decision. In addition, investors are advised that the past performance of investment products does not guarantee future price increases.
– Karen Roberts contributed to an earlier version of this article.
