Borrowing On Margin Can Be Marginal Bet Accounts Make Money Easily Available, But At A Risk

As the bull market on Wall Street swells the value of their brokerage accounts, many investors face the temptation of a new source of money to borrow and spend.

They can, of course, simply sell their stocks, bonds or mutual funds and use the proceeds to pay for a purchase such as a new car.

But if their investments are held with a brokerage firm in what is known as a margin account, they have another option. They can tap into their assets by borrowing against them, often by simply writing a check.

This is a very convenient way to operate. It is also full of hazards and potential misunderstandings.

The traditional purpose of margin loans is to leverage an investment in, say, a stock. By borrowing up to the mandated limit of 50 percent of the purchase price of the stock from your broker, you can multiply your potential profits - and losses.

In recent years, however, more and more use has been made of margin loans as sources of credit for other purposes.

Among the attractions of this type of deal: Relatively low interest rates, and the ability to use your capital without selling assets and incurring capital gains taxes.

Suppose you own a stock that has risen $20,000 in value over the years. You can write a check for a new car on your brokerage account, and keep the stock, hoping it will appreciate some more.

A big problem may arise, however, if the stock falls instead. Once the value of your account drops below a set limit, you will receive a margin call - a notice that some of your holdings will be sold unless you put up more cash or other collateral.

Among other things, this can force you to raise cash or sell assets when you least want to.

Even if the stock doesn’t fall, the cost of your margin loan can erode the value of your investments severely over time. And if you assume that the interest you are charged is deductible, you may be in for an unpleasant surprise at tax time.

Margin interest is deductible as “investment interest” only when you can show that the borrowed money was used to buy assets such as stocks or bonds in quest of an investment return on your money. Even then, you can deduct it only from any investment income you realize in a given year.