Financial Literacy

If you have a brokerage account, you may be eligible for a loan. Many firms make it easy for you to borrow money against the value of the investments you have on account with them. These loans are typically called margin loans. The investments in your account are used as collateral for the loan. You may use the money that you borrow for any purpose, although most investors borrow on margin to purchase securities, i.e., stocks, bonds, etc. So how does a margin loan work?

• Investors are usually permitted to borrow up to 50% of the current market value of their investments (this may be less depending on the volatility of the stock involved and various other factors).
• Interest rates are typically competitive.
• There is usually no fixed repayment schedule, but you may have to put up additional collateral (stocks, bonds, etc.) if the market value of your investments in the account declines.
• Some firms may require that you make up the difference in cash if the market value of your investments used for collateral declines.

Is the Interest Tax-Deductible?

If you take the cash you receive from a margin loan and don't use it to purchase other investments, the interest is not deductible. On the other hand, if you use the money to buy investments, the interest is fully deductible to the extent it does not exceed net investment income. Here is a formula to help you calculate net investment income.

Ordinary dividends + Interest income + Annuities + Royalties − Investment expenses = Net investment income

IMPORTANT NOTE: Qualified dividends and net capital gains are not included in net investment income. But you can make an election on your tax return to include part or all of these amounts in investment income. If you do, these amounts are not eligible to be taxed at the qualified dividends or capital gains tax rates. Contact your tax professional for details.

IMPORTANT NOTE: If you use the money to buy tax-exempt securities, the interest will not be deductible. The theory is that if you don't have to pay income tax on the interest income, you should not be entitled to a deduction for the interest expense.