What is a margin loan?
Buying on margin is a trading strategy that involves borrowing money from a brokerage to purchase investment assets. But what about withdrawing on margin? That’s called a margin loan.
A margin loan (sometimes called a portfolio line of credit, or a secured line of credit) also allows you to borrow from your brokerage, but not strictly for the purpose of buying investment assets. It functions more like a line of credit in that you can use the borrowed money at your own discretion — to pay for home repairs, buy plane tickets, or whatever it is you want to use the money for (subject to any terms the brokerage may have). The investment assets in your margin account serve as the collateral for the loan.
Why would you opt for a margin loan over a more traditional line of credit or bank loan? There are a few reasons:
They typically come with lower interest rates than a standard line of credit or traditional loan.
They can often be quicker to access than a more traditional loan, because they don’t require piles of additional paperwork or additional credit checks.
They don’t have a prescribed repayment schedule (though the lender can demand repayment at any time).
While these are unique benefits of margin loans, there are also a bunch of considerations to weigh before you start to withdraw funds.
Buying on margin vs. margin loan
Buying on margin and a margin loan share some basic similarities and some key differences.
Margin accounts
Whether you want to buy on margin to invest, or use a margin loan to borrow funds for other purposes, you need a margin account. Opening a margin account requires an application process, and brokerages will typically need more information or have higher requirements than what’s needed to open other types of accounts.
Collateral
When you buy on margin, the securities in your account serve as collateral. When you sell your position, the brokerage will pay itself back the amount owed plus any interest charges before passing any balance to you.
When you withdraw funds from your margin account you’re also borrowing against the investments you hold at the brokerage. You repay the loan by either depositing cash or selling securities in your account.
In either scenario, how much you can borrow will vary based on the positions in your account. Generally, the amount you can borrow is equal to or similar to the buying power in your account.
Interest
Whether you buy on margin or withdraw from margin, you will be charged interest on the loan. The amount of interest you pay is based on the interest rate, the amount borrowed, and the length of time you borrow the money.
When you buy investment assets on margin in Canada, you can — for tax purposes — deduct the interest paid from the gains in your account, if the investments are earning investment income (paying interest or dividends). When you use a margin loan like a line of credit, for personal expenses, loan interest is not tax deductible.
Margin calls
A margin account, no matter how it’s used, requires you to maintain a certain level of equity (what’s usually called the “maintenance margin”).If the equity in your account falls below the maintenance margin your brokerage will issue a margin call. It’s a requirement to fund your account, either by selling securities in the account or transferring cash or margin-eligible securities to your account.
In the case of margin loans, a margin call can occur when your borrowing exceeds your available margin balance.
In either scenario, if you don’t bring your account balance up by the specified time frame determined by your brokerage, they may liquidate your securities.
Benefits of margin loans
Speed and convenience. If you have a margin account in good standing, it can be faster and simpler to access a margin loan than a traditional loan or line of credit. Typically no additional forms, credit checks, or vetting are required.
Interest rates. The interest rate you pay on a margin loan will often be lower than that charged by a bank on a line of credit or other loan. Margin loan interest rates can often be particularly low for investors with large portfolios, since they have more collateral to secure the loan.
Flexible repayment. You can pay back a margin loan on your own schedule (again, so long as your account is in good standing).
Risks of margin loans
Margin calls. If you don’t maintain the required margin in your account and/or if the value of your investments (your collateral) dips below the margin requirement set out by your brokerage, you’ll face a margin call. When that happens, you’ll have to sell assets in the account, deposit margin eligible securities or cash. If you don’t do that in the timeframe required by your brokerage, they can sell off your assets, affecting your investment strategy and forcing you to lose your position.
Complexity. Managing a margin loan is more complicated than a traditional line of credit. You need to understand sophisticated investment principles, track market fluctuations, and regularly monitor your account.
Are margin loans for you?
For those with margin accounts, a margin loan can be an appealing way of accessing extra cash for a bigger purchase. But the complexity and potential risks mean that its use should be reserved for experienced investors who understand the ins and outs — just like trading on margin.
