Potential home buyers who need fast cash to close a deal or end a bidding war are turning to margin loans for short-term financing.
By ANYA MARTIN
Sometimes in real estate, speed wins.
An increasing number of potential home buyers who need fast cash to close a deal or end a bidding war are turning to margin loans for short-term financing.
Ameriprise Financial Inc., AMP +0.25%for example, has issued margin loans to clients pursuing a home with multiple offers, an increasingly common occurrence in high-priced California residential markets where demand outstrips supply. “A person with easy access to cash may have a leg up over someone who has to have long-term financing,” said Tucker Watkins, a private wealth adviser with the wealth-management company based in Irvine, Calif.
Margin loans are backed by a borrower’s investments. Typically, brokerage firms permit loan amounts of up to 50% of the portfolio’s value at the time the loan is originated. The money can be used for almost anything, including bridge financing—when a buyer needs money to close on a new home when the current home hasn’t been sold yet.
Spurred by a bull market in early 2013, investors embraced margin loans with a passion, driving margin debt to $384.3 billion in New York Stock Exchange member firms in April, according exchange data. The previous record of $381.4 billion in margin debt was set in July 2007, just before the market downturn.
“We’ve had a major rise in equity
Such clients typically will use the margin loan as a short-term strategy and then apply for a jumbo mortgage or other financing after the home purchase closes, Mr. Watkins said. That reduces the risk of a margin call, a demand by the broker to immediately repay the loan when the portfolio’s market value falls.
Margin loans can have some pricing advantages over mortgages and other more traditional loans. Borrowers pay no closing costs, no property appraisal is required and there are no prepayment penalties. Borrowers don’t even have to make monthly interest payments, though interest will then accrue on the unpaid interest, raising the borrower’s liability over time, said Randy Carver, an investment adviser with Carver Financial Services Inc. in Mentor, Ohio.
Interest rates for margin loans can vary widely. For example, Interactive Brokers Group IBKR +1.03%extended over $10 billion in margin loans at an average rate of 1.14% in the first quarter of 2013. As at many brokerages, rates decrease as the borrowed amount increases. Charles Schwab SCHW -0.09%charges 8% in interest for the first $25,000 to $49,999 of the loan, 6.75% from $250,000 to $999,999, and 6% for amounts over $2 million.
By comparison, the average interest rate for a 30-year, fixed-rate jumbo was 4.23%, and a five-year, adjustable-rate mortgage had a 2.81% rate on June 14, according to the Mortgage Bankers Association.
Margin loans also may have tax benefits. If a home buyer cashes out stocks for a cash down payment on a house, he may have to pay capital-gains taxes. Interest on a margin loan generally is tax deductible. “Avoiding capital gains is often a reason why someone may use a margin loan instead of selling a security,” Mr. Watkins said.
There is a downside. Brokers have what is called a maintenance margin. If the portfolio’s value drops below this threshold, the borrower may be subject to a margin call. In that case, a borrower must immediately deposit cash to bring their securities back to the maintenance margin percentage. Otherwise the brokerage firm will sell assets to bring the portfolio back in line.
“Using short-term financing to fund long term purchases is one of the riskiest things to do, particularly when markets are as turbulent as they have been in recent weeks,” Mr. McCain said.
Some more considerations:
• Don’t borrow up to margin limits. Ameriprise advises not to borrow more than 30% of the value of their securities to reduce the risk of a margin call, Mr. Watkins said.
• Borrowers still have to qualify. Brokerages typically run a credit check and ask borrowers to fill out a questionnaire that includes their income, net worth and other monthly debt payments.
• Check broker commissions. While margin loans don’t have closing costs, brokerage firms do charge fees and commissions, such as $9.99 at TD Ameritrade, AMTD -0.69%if shares are sold to maintain the required equity in the account.
Corrections & Amplifications
An earlier version of this article indicated that TD Ameritrade charged a $9.99 fee per 100 shares sold to maintain the balance of a portfolio. In fact, the fee is not based in a minimum or maximum number of shares sold.