What are securities loans (aka margin loans) and how to use them

Securities loans, or margin loans, are loans against non-retirement investment accounts. That account typically contains stocks, bonds or diversified assets which are pledged as collateral on the loan.

These loans are issued from your custodian (Fidelity, Schwab, etc.) or can be issued from a bank.

Watch this video to learn more!

Transcript:

In today's video, we're going to be talking about securities loans, commonly referred to as margin loans. I'm Chris Kaminski, partner and co -founder here with Consilio Wealth. We specialize in working with technology professionals, specifically with Amazon, Microsoft, Meta, and Google.

All right, what are securities loans? Securities loans are loans against non-retirement investment accounts. That investment account could contain a diversified portfolio. It could contain a individual stock.

Generally speaking, your custodian, so that would be like Fidelity or Schwab or wherever your accounts are sitting, your custodian can issue you a loan using the holdings of the account, the stock holdings, as collateral. Generally speaking, you can loan up to 50, sometimes 70% of the value of these holdings. Benefit of this is the loans are tax-free because you didn't sell anything, and you generally don't have to pay interest on these loans because the interest is just added back to the principal balance.

Loans are variable interest rates almost always. Sometimes they can be fixed, but just plan on it being variable. And it tends to be something like the Fed funds rate plus two or plus three or SOFR (Secured Overnight Financing Rate) plus two or something like that along those lines. Bigger loans tend to get better rates. Smaller loans tend to get higher rates. Now, if you don't know what SOFR is or Fed funds is, just Google that. If you Google what is the current Fed funds rate, you'll be able to see what it is.

So, a loan like this can be used for really anything you want. You could use a loan for a tax bill. You could use a loan for a down payment on a house. You could finance your kitchen or model with a loan like this. Redo your backyard with a loan like this. Really anything that you want to use a loan for is up to you. The risks in doing this is that if the underlying holdings, the stock, or the portfolio that you have that is collateral for the loan.

If those holdings decline in value, you could hit what's called a margin call. It's not a margin call like the movies necessarily, but a margin call is basically saying, hey, your collateral balance is not big enough anymore to guarantee the loan. So, we're requiring you to post collateral. You either will be forced to sell some of your holdings in order to reduce the margin of the margin loan or the amount of the margin loan, or you have to bring new cash in to reduce the loan.

Generally speaking, we advise clients to not take more than a 50% margin balance. I mentioned that sometimes you can get approved up to 70%. We don't like doing that because the risk of margin call is quite high with even small market movements. If you keep these loans between 30 and 50%, you're a little bit safer. If you are doing this against an individual stock, take note that that individual stock can be considerably more volatile than a diversified portfolio.

But even in a year like say 2020, when COVID started and lockdown started and the stock market fell by about 30% in a mere two weeks, note that even diversified portfolios can fall and can fall quickly. As far as paying these loans back, there aren't set payment schedules. You can make lump sum payments, you can make monthly payments, you can make no payments until you further decide to do so. One of the advantages of these loans is that taking a loan against your investments does not go anywhere on your credit.

If you are using this as a down payment, you still should let your mortgage broker know that you are going to be taking a margin loan in order to fund the down payment.

However, it doesn't go on your credit. The reason why it doesn't go on your credit is because there's no payment required, and the collateral asset is your stock. The custodian knows that they can force you to sell your stock before that stock goes below the loan balance and ultimately, they're covered. So therefore, it's not a liability. The advantage to that is it doesn't affect your debt-to-income ratio. So, your mortgage broker doesn't have to factor it in to your debt-to-income ratio when qualifying you for a mortgage.

That's about it. You are now an expert in securities loans. Hope this video was helpful.