Author Topic: Understanding Margin Loans  (Read 2183 times)

WalkaboutStache

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Understanding Margin Loans
« on: July 19, 2022, 06:56:47 PM »
Hi everyone,

I ran into a situation that is almost exactly like the one MMM discusses in the margin loan posting, and I am trying to understand the math.  Here is a situation:

I found a good house for sale for about USD 277K.  Add closing costs and all that crazy stuff, and let's call it 300K.

Currently, I have 800K in equities (VOO), and 100K in treasuries.  I also have about 50K in cash.

IB tells me this:

Portfolio Initial Margin USD $79,725.12
Reg-T Initial Margin USD $402,882.12
Portfolio Maintenance Margin USD $72,477.38
Reg-T Maintenance Margin USD $201,441.06

If I borrow all 300K against the 800K equities position, what happens?  Is the below right?

1. My equities portfolio value drops to 500K.
2. I am very close to the Initial Margin, not so close to the Maintenance Margin.

What I don't quite understand is where the "oh, shit!" level kicks in.  Is it when the equities portfolio value hits ~402 (i.e a 12.5% drop in the value of my VOO equities), or is it when it hits ~201 (i.e. a drop of more than 30%)?  I have no idea what the Portfolio Maintenance Margin means, so I am even less comfortable.

Realistically, I am unlikely to take this plunge because there are non-financial considerations at play, but I will eventually want to buy something (most likely something cheaper) and this is a question that keeps recurring to me. Also, unless I understand how this stuff works, I am not going near margin loans.  I can also buy a 50k house and be happy.  Bad location for everyone else, paradise for me.

Also, I am not in the US, so other sources of financing are not available at interest rates that make any sense (over 10% currently).  Cheap housing prices giveth, the banks taketh away.

Feel free to punch.  I would rather get them here than in my wallet.



« Last Edit: July 19, 2022, 08:29:18 PM by WalkaboutStache »

MustacheAndaHalf

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Re: Understanding Margin Loans
« Reply #1 on: July 20, 2022, 06:33:46 AM »
When you take out a margin loan, you get a negative cash balance in your margin account (at IBKR).  Periodically, interest drives that negative balance slightly more negative.

I haven't withdrawn cash on margin, but I believe you'd have $300k at a bank, wired from IBKR, and then IBKR would show -300k balance.  Against that you have $800k of S&P 500, which could fall in a crash.  I would encourage you to think of it as two separate balances, since the loan will not shrink on its own - but your equities can.

If you do take out a margin loan of $300k, make sure you upgrade to an IBKR Pro account and pay $10/month.  You'll save 1% on margin interest, or about $3,000/year versus paying $120/year.  Also note the margin loan interest rate can change (and has) as interest rates go up.

Financial.Velociraptor

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Re: Understanding Margin Loans
« Reply #2 on: July 20, 2022, 02:07:33 PM »


Currently, I have 800K in equities (VOO), and 100K in treasuries.  I also have about 50K in cash.

IB tells me this:

Portfolio Initial Margin USD $79,725.12
Reg-T Initial Margin USD $402,882.12
Portfolio Maintenance Margin USD $72,477.38
Reg-T Maintenance Margin USD $201,441.06

If I borrow all 300K against the 800K equities position, what happens? 


OK, is the 800 (equity) 100 (T) and 50 ($) all within your IB brokerage account?  That would give me more ease.  Borrowing 300/800 is 37.5%!  You borrow against your "Net Liquidation Value" not your net equity position only.    Your net liquidation cannot fall below the maintenance margin or IB uses an automated bot to liquidate positions until you are compliant again in whatever way provides IB with the most safety. (It does not consider your tax consequences!)  Voo, Treasuries, and Cash should all be safe from surprise margin requirement increases.

Also, unless you have gone through some paperwork with IB, the default is Regulation T margin.  You have to apply for Portfolio level service (you easily qualify).  I'm going to assume you have RegT.   RegT gives you up to 50% margin.  Portfolio gives you up to 5x margin (don't do it!)   That is, apply for Portfolio for more breathing room but use the RegT numbers to calculate your loan.  (Note -  you will no longer be considered a retail client eligible for free equity trades.  You will pay commissions again but they are trivial at IB).

So if we take a 950k liquidation value, you can borrow about 550k (950-402.882).  A 300k loan uses up about 60% of your wiggle room.  If your equities drop by 50% from here, your net liquidation is 400+100+50 (about) 550k BEFORE THE 300k loan.  You are now borrowing more than half your net liquidation value and will be partially liquidated, at the bottom of the market no less. 

This can be done "safely" if you hedge with a long puts on VOO or SPY, e.g. buy insurance against a market collapse.  But the cost drag of the put might make the interest rate savings not worth it.  Note you can deduct mortgage interest but not portfolio interest from your taxes (unless you happen to be running a fund with other people's money).  Also, you can probably get a fixed rate mortgage at a very favorable rate for 15 year fixed if you declare your treasuries as collateral.  Your IB loan is fully variable and we are in an inflationary cycle.  Just think you should consider interest rate risk here too.

Personally, all my leverage right now (and I use IB) is either fully hedged with options or used to establish market neutral "pairs" trades.  And I keep a net cash position in the account.  That is, I pay no interest (ok, I pay a little in borrow fees to hold some growth ETFs short against value ETFs).  Now is not a good time to be loading up on brokerage debt, IMO.

WalkaboutStache

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Re: Understanding Margin Loans
« Reply #3 on: July 20, 2022, 02:24:05 PM »
Excellent advice, and it goes with my gut feeling.  Thank you!

On an unrelated note, my other gut feeling is that we may have turned the corner on this downturn. Would I bet on it? Hell's, no, but I think the greatest if the greater fools have washed out and from here onwards we are looking primarily at housekeeping.

MustacheAndaHalf

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Re: Understanding Margin Loans
« Reply #4 on: July 25, 2022, 06:29:41 AM »
Excellent advice, and it goes with my gut feeling.  Thank you!

On an unrelated note, my other gut feeling is that we may have turned the corner on this downturn. Would I bet on it? Hell's, no, but I think the greatest if the greater fools have washed out and from here onwards we are looking primarily at housekeeping.
I switched to 80% cash a month ago, and in another month I plan to invest bearishly again.  Consider this year's circumstances for a moment: down about 20%, inflation not under control, and a likely recession hasn't occurred yet.  Does a year like this really sound like a -20% drop?  It doesn't to me, so I plan to wait for further drops.

One thing to keep in mind about margin - your gut will be wrong.  If everyone is happy with stock market returns, and everyone is telling you to buy more and profit... that's a terrible time to take out a margin loan.  It has the hallmarks of a local peak.  But when nobody even wants to buy stocks with cash, and people think the horrific losses will continue for years... well, when your gut can barely stand it, that's actually a better time to buy with leverage.  After a crash, most of the risk goes away - it's already been realized.

It's a bit like how people nearing bankruptcy can't sign up for any new credit cards... but once they declare bankruptcy, they find it much easier to get credit.  That's because the countdown timer on their next crash - their next bankruptcy - has been reset.

MustacheAndaHalf

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Re: Understanding Margin Loans
« Reply #5 on: July 25, 2022, 06:34:19 AM »
Also, unless you have gone through some paperwork with IB, the default is Regulation T margin.  You have to apply for Portfolio level service (you easily qualify).  I'm going to assume you have RegT.   RegT gives you up to 50% margin.  Portfolio gives you up to 5x margin (don't do it!)   That is, apply for Portfolio for more breathing room but use the RegT numbers to calculate your loan.  (Note -  you will no longer be considered a retail client eligible for free equity trades.  You will pay commissions again but they are trivial at IB).
Does "Portfolio margin" mean IBKR will wait longer before it begins to liquidate positions?  (Assuming everything else is the same)

I found this IBKR page while poking around:
"An existing account must have at least USD 110,000 (or USD equivalent) in Net Liquidation Value to be eligible to upgrade to a Portfolio Margin account"
https://www.interactivebrokers.com/en/trading/margin-ssf.php

Financial.Velociraptor

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Re: Understanding Margin Loans
« Reply #6 on: July 26, 2022, 01:05:31 PM »
Also, unless you have gone through some paperwork with IB, the default is Regulation T margin.  You have to apply for Portfolio level service (you easily qualify).  I'm going to assume you have RegT.   RegT gives you up to 50% margin.  Portfolio gives you up to 5x margin (don't do it!)   That is, apply for Portfolio for more breathing room but use the RegT numbers to calculate your loan.  (Note -  you will no longer be considered a retail client eligible for free equity trades.  You will pay commissions again but they are trivial at IB).
Does "Portfolio margin" mean IBKR will wait longer before it begins to liquidate positions?  (Assuming everything else is the same)

I found this IBKR page while poking around:
"An existing account must have at least USD 110,000 (or USD equivalent) in Net Liquidation Value to be eligible to upgrade to a Portfolio Margin account"
https://www.interactivebrokers.com/en/trading/margin-ssf.php

What do you mean by "wait longer?"  Under PM, you are allowed to borrow more, if you borrow the same as a Reg-T borrower, you  have a larger margin cushion.  In either scenario, a margin violation of 1 cent triggers an automated algorithm that liquidates positions as it most benefits IB to do so until you are back in compliance.  This particularly bad if your violation is because you were compliant at close but not for overnight margin.  You get liquidated into a low liquidity after hours market.

WalkaboutStache

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Re: Understanding Margin Loans
« Reply #7 on: July 27, 2022, 03:53:48 AM »
Excellent advice, and it goes with my gut feeling.  Thank you!

On an unrelated note, my other gut feeling is that we may have turned the corner on this downturn. Would I bet on it? Hell's, no, but I think the greatest if the greater fools have washed out and from here onwards we are looking primarily at housekeeping.
I switched to 80% cash a month ago, and in another month I plan to invest bearishly again.  Consider this year's circumstances for a moment: down about 20%, inflation not under control, and a likely recession hasn't occurred yet.  Does a year like this really sound like a -20% drop?  It doesn't to me, so I plan to wait for further drops.

One thing to keep in mind about margin - your gut will be wrong.  If everyone is happy with stock market returns, and everyone is telling you to buy more and profit... that's a terrible time to take out a margin loan.  It has the hallmarks of a local peak.  But when nobody even wants to buy stocks with cash, and people think the horrific losses will continue for years... well, when your gut can barely stand it, that's actually a better time to buy with leverage.  After a crash, most of the risk goes away - it's already been realized.

It's a bit like how people nearing bankruptcy can't sign up for any new credit cards... but once they declare bankruptcy, they find it much easier to get credit.  That's because the countdown timer on their next crash - their next bankruptcy - has been reset.


I think I gave the wrong impression.  @Financial.Velociraptor posted a really clear answer which also explained why my initial question described a bad idea.  So I agreed that it went with my gut feeling - i.e. that I would not take a margin loan.

The bit after that was meant to be just a little side note saying that I thought the worst may be over.  I do think it may be, though I am not betting on it.

In any case, your thoughts on piling on risk are excellent. Yet one more reason not to do it.

MustacheAndaHalf

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Re: Understanding Margin Loans
« Reply #8 on: July 27, 2022, 06:27:51 AM »
Also, unless you have gone through some paperwork with IB, the default is Regulation T margin.  You have to apply for Portfolio level service (you easily qualify).  I'm going to assume you have RegT.   RegT gives you up to 50% margin.  Portfolio gives you up to 5x margin (don't do it!)   That is, apply for Portfolio for more breathing room but use the RegT numbers to calculate your loan.  (Note -  you will no longer be considered a retail client eligible for free equity trades.  You will pay commissions again but they are trivial at IB).
Does "Portfolio margin" mean IBKR will wait longer before it begins to liquidate positions?  (Assuming everything else is the same)

I found this IBKR page while poking around:
"An existing account must have at least USD 110,000 (or USD equivalent) in Net Liquidation Value to be eligible to upgrade to a Portfolio Margin account"
https://www.interactivebrokers.com/en/trading/margin-ssf.php

What do you mean by "wait longer?"  Under PM, you are allowed to borrow more, if you borrow the same as a Reg-T borrower, you  have a larger margin cushion.  In either scenario, a margin violation of 1 cent triggers an automated algorithm that liquidates positions as it most benefits IB to do so until you are back in compliance.  This particularly bad if your violation is because you were compliant at close but not for overnight margin.  You get liquidated into a low liquidity after hours market.
Yes, that was my meaning: borrowing the same amount on the same assets, giving a larger margin cushion.

"Note that IBKR generally initiates expiration related liquidations 2 hours prior to the close, but reserves the right to begin this process sooner or later should conditions warrant."
https://ibkr.info/node/1767#:~:text=Note%20that%20IBKR%20generally%20initiates,or%20later%20should%20conditions%20warrant.

Owing to picking up nickels in front of a steamroller, I once found my IBKR account had zero liquidity left.  I decided to close positions at severe losses, accepting my mistake.  I've wondered why I was given time to do that - and the above quote seems to shed light on why.