Using margin debt or borrowing against brokerage accounts is back in vogue in 2013. According to the NYSE, investors borrowed $384.4 billion against their investments in April 2013 eclipsing the previous all time high set in June 2007.
When you borrow on margin, you are pledging securities like stocks and bonds in your brokerage account to obtain loans from the brokerage firm. Typically, these borrowed funds can be used at the discretion of the borrower. For real estate investors, borrowing on margin can be a very appealing alternative to traditional bank financing and other types of hard money financing.
Here are 5 advantages to using margin loans to finance your real estate operation:
1: Quick Access to Funds
Margin accounts essentially work like a line of credit. Once you have the margin account set up with your brokerage, you can borrow the funds as needed. Many brokerage firms require you to keep between 30-50 percent of the total market value of the securities in your margin account at all times.
2: Competitive Interest rates and Transaction Costs
Margin accounts offer competitive interest rates compared to other short term borrowing options and typically have low or no transaction costs associated with using the funds. Note that margin loans often have a base rate + structure which is equivalent to a floating rate (ex: Base rate of 5.5% + 3.625%) The base rate is set by the brokerage with reference to commercially recognized interest rates. If interest rates spike, your borrowing costs could increase very quickly.
3. Cash for Acquisitions and Gap Financing
For professional real estate investors and flippers, using margin debt for cash offers can make the difference between getting a propertyand missing a great opportunity. Cash is king in this market and offers with financing contingencies go to the back of the line. Margin debt is great for Gap Financing too. For instance, an investor who just acquired a multifamily income property may want to finance the rehab costs with a traditional construction loan that could take 30-60 days to be approved. The investor could use funds from his margin account to begin work and then pay back the principal and interest with the construction financing when the loan is approved.
4. Investment Interest is Tax Deductible
The interest paid on margin loans is known as qualified investment interest if the funds are used for taxable investment purposes and not your own personal reasons. Investing in income property counts but using the funds to buy a personal residence does not. Investment interest expenses are used to offset your net taxable investment income.
5. No Set Repayment Schedule
For most margin loans, you can repay the principal at your convenience. This is ideal for real estate investors who need to sell or refinance a property in order to repay the borrowed funds. You could also use the proceeds from the sale of securities or dividend payments from securities to repay the principal balance. Though the repayment schedule for the principal is open-ended, monthly interest charges will accrue to your account.
Margin loans can open a lot of doors and are a great alternative for traditional bank loans, especially for short term real estate investments. There are risks associated with borrowing on margin that you should be aware of. Margin accounts are available for investors who can tolerate the risk of fluctuating markets and have the ability to meet margin calls. The U.S. Securities and Exchange Commission is a good resource for reading up on the risks associated with borrowing on margin.