Margin Loans Can Cut Borrowing Costs With Stocks As Collateral, Interest Rates Are Lowered

Sick of paying 15, 18, or even 21 percent on your credit-card bills?

What if it were 9 percent or less?

If this sounds good, you might consider opening a margin account, allowing you to borrow money from your broker by using your stocks and bonds as collateral.

One little-known trick: You can borrow against most regular mutual fund investments if you move them from the fund company to a margin account at your broker’s.

In a margin loan, the securities you hold in your brokerage account are used as collateral, just as your auto loan and mortgage are secured by your car and house.

Federal regulations allow you to borrow to buy new securities so long as the loan doesn’t exceed half the value of all securities in the account.

If you owned $10,000 worth of stock, you could borrow $10,000 to invest in stock, bonds or mutual funds - your $10,000 loan equals half the account’s $20,000 value. Or you could borrow $5,000 in cash for any purpose.

The limit is lower for cash because you’re not buying new securities that serve as collateral.

Once the loan is made, you are subject to a “minimum maintenance” limit based on your net equity, which is the value of the securities minus your margin debt. Most brokerages require that your net equity equal at least 30 percent of your securities’ market value.

In the example above, you start with net equity of 50 percent - $20,000 worth of stock less $10,000 in debt. Now suppose the stock’s price drops from $10 to $7.20. Your investment is now $14,400. You still have $10,000 in debt and your net equity is down to $4,400. That’s just over 30 percent of the shares’ market value.

If the share price falls any further, you’ll face a margin call. You’d have to immediately put more money or securities into the account to get back to the 30 percent minimum. If you don’t furnish additional collateral, the broker will sell some of your shares to pay off enough of the loan to get you back to the 30 percent minimum.

In the example, the shares could drop by only 28 percent - from $10 to $7.20 - to put you on the verge of a margin call. But you can reduce the risk by borrowing less.

Since margin loans are collateralized, interest rates are lower than they are for unsecured credit cards. For example, Charles Schwab charges 8.5 percent on a margin loan of $10,000 or less.

A few fund companies with brokerage operations allow investors to open margin accounts using their fund shares as collateral.