RUEDI: Using margin for short-term financing | Business

Occasionally, I’m asked about addressing short-term financing needs. It often involves timing the sale of one property with the purchase of another. For example, if closing dates overlap for a period when purchasing a home, a shortfall can occur causing the need for additional capital. The traditional approach to that shortfall could be a traditional bank loan, using existing cash savings, or perhaps withdrawing from an investment account. There is a potential alternative solution that could prove to yield some additional benefits, if implemented with caution.

Borrowing on margin involves taking a loan from your own investment accounts without selling any of the investments. Some custodians offer this feature on non-retirement accounts. IRAs, Roth IRAs, and 401ks are not eligible for this type of borrowing. Like traditional loans, margin borrowing has an interest component that is applied to the outstanding loan balance. Often these borrowing costs are tied to the current prime rate, which is heavily influenced by the current Federal Reserve funds rate, plus an additional amount.

Compared to traditional loan underwriting, margin lending can finalize more quickly. Used in the appropriate situation, margin lending may offer an attractive alternative because you can borrow money at a relatively low rate without disturbing an investment portfolio, which may have returns in excess of the costs. If the need for additional funds is shorter term, margin borrowing could also yield some potential tax benefits. Rather than selling investments in the portfolio and incurring potential capital gains, margin borrowing avoids any disturbance to historical cost basis. You can pay down margin loans over time through dividends or interest earned in the portfolio, periodic payments from bank cash, or pay the full amount at once when you receive payment from an outside transaction.

Keep in mind that margin borrowing is subject to certain limitations and risks. Many custodians that offer this option restrict the loan amount to fifty percent of the eligible account balance. Because investment returns can vary greatly over a short period of time, only borrowing a portion of the available amount is usually prudent. The portfolio’s investment performance could cause the outstanding margin balance to exceed the maximum level. If that were to happen, the custodian could sell part of the portfolio to pay down the outstanding balance until it falls below the maximum threshold.

Consulting with your financial advisor and/or tax advisor is a critical first step if you’re considering margin financing. Remember that plans are always subject to change and short-term funding needs can become longer term needs if the unexpected happens. Be sure you have other contingencies in place should they become necessary.