When You Need Cash: Home Equity or Margin Loan

When a large, unexpected expense crops up, you don’t want to increase the cost by using a less-than-optimum way to raise the needed cash. The most common unplanned retirement expenses are medical treatment, home repairs, taxes and help for family members.

Of course, when you don’t have enough cash on hand you could sell an investment or take a traditional IRA distribution. But those actions could trigger taxes, increasing your outlay. When you need to raise a significant amount of cash in a hurry, the two best options usually are a home equity line of credit (HELOC) or margin loan against a brokerage account. The best choice depends on your situation. A HELOC must be set up in advance.

You must shop for a lender offering attractive terms, then apply for a loan. The lender then reviews the application, which can take from a few days to a few weeks. If the application is approved, there likely will be an appraisal of your residence, title search and other actions usually associated with the purchase of a property. Finally, the loan agreement will be closed, with the loan secured by the residence. There are costs to setting up a HELOC, which vary between lenders.

You’re likely to pay an application fee, title search fee, inspection expense and other costs. You might have to pay for title insurance. There also  be points charged to close the loan, depending on the HELOC you select.

The process typically takes 30 days or longer. If you want the option of using a HELOC to raise emergency funds, you should set up a HELOC with a lender before you need cash. Then, you draw on the HELOC, usually by writing a check or making an electronic transfer, when you need money. Once you establish a HELOC, usually no interest is charged until you borrow money.

Interest usually is a variable rate. Once you borrow against the HELOC, the repayment schedule varies by lender. Some require only interest payments, at least for a time. Others want both interest and principal payments. In either case, payments usually begin within a month after cash is borrowed. A margin loan from a broker can be simpler, faster and sometimes less expensive.

Most people associate margin loans with aggressive investors borrowing to buy stocks or other investments. But the proceeds of a margin loan can be used for any purpose. A margin loan doesn’t require a long application or credit checks, property appraisals and other steps. At most, you complete a simple online application or make a phone call. The loan is approved within days at most and sometimes within hours. The investments in the account are security for the loan. You generally can borrow up to half of the portfolio’s value. A margin loan can be taken only against a taxable brokerage account, not an IRA or other qualified retirement plan.

Interest rates on margin loans fluctuate with market interest rates, and the rates vary considerably between brokers. Margin loan rates almost always are less than credit card interest rates. Some brokers charge higher rates than the average HELOC, but some brokers charge rates lower than or competitive with HELOCs.

Interactive Brokers and Robinhood are two brokers known for offering margin loans with low rates. Margin loans typically don’t have required minimum payments or set repayment plans. You repay the loan plus interest when you want. But inter- est will be charged each day the loan is outstanding.

A key to a margin loan is your out- standing balance never can be more than half the value of the securities pledged against the loan. If you borrow close to the 50% limit and don’t make any repayments, the interest charges could push your balance above the 50% limit. Also, the 50% limit is redetermined each day the loan is outstanding.

You might be comfortably below the 50% limit when the loan is taken. But a decline in the value of your investments could put you above the limit. When the limit is exceeded, the broker issues a margin call. You have a brief time to bring your account into compliance by either paying part of the loan or adding cash or securities to your account. If you don’t meet the deadline, the broker will sell securities from your account to repay part of the loan.

That could trigger taxes for you, and the securities probably will be sold at unfavorable prices. They also might not be the securities you would choose to sell. A margin loan can be a fast, low-cost way to raise cash in a hurry without having to sell investments or take retirement plan distributions. But it also can carry some longer-term risks and costs. The best strategy is to consider a margin loan as a way to raise cash quickly. But be sure to limit the amount you borrow so exceeding the 50% limit in a sudden market down- turn is unlikely.

Then, develop a plan to repay the loan. For example, after taking a mar- gin loan you might apply for a HELOC or a reverse mortgage HELOC (see our September 2023 issue for details about reverse mortgages) to repay the mar- gin loan. Or you could develop a plan to sell securities and take IRA distributions in ways that minimize taxes.might