Robinhood Margin 2.5% vs Mortgage Investing

[EricEng]

So I know a lot who prescribe to the common advice of not paying your mortgage off when it is a low interest rate so you can invest, which is leveraged investing similar to margin investing, albeit without the risk of being margin called.

I just saw Robinhood advertising their new 2.5% margin fees when I'm used to see these around 7-10% at other investment firms.  This actually sounds better than my 2.75% mortgage if you do it as a small portion of your portfolio where you wouldn't risk margin calls, such as only 20-30% of your account balance.  Interactive brokers looks to have rates around 1.09% (or am I missing a catch on that?).  If investing your mortgage in stocks is considered sound, would pulling out a margin of 20-30% be considered wise?

IE:  1 mill balance invest in equities, pull out another $200-300k to also invest?  Seems like it would pay off in the long run just like with a mortgage. Is it just a question of how much leverage and risk you are comfortable with?  Is there a big catch I'm missing?  Obviously you could easily over do it and get burned if you try to margin the max available. 

Full Disclosure: I don't use Robinhood app and probably never will because I think it is an unreliable company with sloppy software.  I have also never invested on Margin, but did cash out the max I could on my home at 2.75% for more leverage while investing and it has paid off very well these last few years. I also paid off a previous home and missed opportunity market gains of around $80-100k in just 3 years.

[secondcor521]

I'm no expert and I've never done margin.  In my view, in general, investing up to 100% equities can make sense (in fact I tend to be around 96/4), but beyond 100% equities, the risk/reward ratio diverges sharply - you might get 10% gains but you're also guaranteeing 2.5% losses.

I don't know what the margin ratios are for a margin call.  Even with $1M in equities, you might have gotten a margin call in March of this year.  And my understanding is that you don't get to decide what to sell; they can sell anything in your margin account.  And you get whatever tax consequences result (i.e., you realize a capital gain or loss at that point, which may or may not be what you want).

Margin interest is not deductible.  Home mortgage interest can be, although it's obviously more limited since TCJA.

If you have a margin account and hold dividend paying securities, there could be tax implications.  Generally, you may think you're receiving qualified dividends (taxed at a preferenced rate), but you may actually be receiving substitute payments (taxed as ordinary income and higher rates).

You seem to be alluding to two different ideas:  Start with a $1M portfolio and a $250K mortgage.  Then are you suggesting (a) borrowing $250K on margin and paying off the mortgage, or (b) borrowing on margin to go up to $1.25M portfolio and keeping the $250K mortgage?  These have two very different risk profiles to me.  I would never do (b).  I probably wouldn't do (a) either for the reasons already outlined, but I can see the logic.  It might be helpful to clarify what you're thinking here for more specific feedback.

[hodedofome]

I use Interactive Brokers margin extensively. It’s not a scam, they’ve been the low rate margin broker since at least the mid 2000s.

[EricEng]

I'm no expert and I've never done margin.  In my view, in general, investing up to 100% equities can make sense (in fact I tend to be around 96/4), but beyond 100% equities, the risk/reward ratio diverges sharply - you might get 10% gains but you're also guaranteeing 2.5% losses.

You are only guranateeing 2.5% loss on the margin amount, not your whole portfolio.
I personally do about 90/10 for stocks/bonds.

I don't know what the margin ratios are for a margin call.  Even with $1M in equities, you might have gotten a margin call in March of this year.  And my understanding is that you don't get to decide what to sell; they can sell anything in your margin account.  And you get whatever tax consequences result (i.e., you realize a capital gain or loss at that point, which may or may not be what you want).

In my example, a margin call would be nearly impossible without market dropping rediculous amounts (see math below).  Most margin calls in regular times are around 25%.
https://www.investopedia.com/terms/m/margincall.asp

Real World Example of a Margin Call
Suppose an investor buys $100,000 of Apple Inc. using $50,000 of his own funds. The investor borrows the remaining $50,000 from their broker. The investor's broker has a maintenance margin of 25%. At the time of purchase, the investor's equity as a percentage is 50%. The investor's equity is calculated using this formula: Investor's Equity As Percentage = (Market Value of Securities – Borrowed Funds) / Market Value of Securities. So, in our example: ($100,000 – $50,000) / ($100,000) = 50%.

Versus in my case where I was arguing only expanding your portfolio by say 25% of your initial amount rather than 100% which is typical max.  For example, you with 100k and margin 25k would work out like this:
125,000-25,000(margin)/125k=80%.
Even if your margin investment went to 0, you would still be at 100k-25k/125k=60%, well above the 25% margin call.
You wouldn't risk a margin call until your 125k portfolio dropped to $32k, a 74.4% loss which is more than even most peoples 50% market drop estimats for big crashes.

Margin interest is not deductible.  Home mortgage interest can be, although it's obviously more limited since TCJA.

I don't see this as a factor anymore because it is nearly impossible to deduct mortgage interest by overcoming the 24k standard married deduction.

If you have a margin account and hold dividend paying securities, there could be tax implications.  Generally, you may think you're receiving qualified dividends (taxed at a preferenced rate), but you may actually be receiving substitute payments (taxed as ordinary income and higher rates).

Hadn't considered that.  Although I don't think dividends would be a large part of this.

You seem to be alluding to two different ideas:  Start with a $1M portfolio and a $250K mortgage.  Then are you suggesting (a) borrowing $250K on margin and paying off the mortgage, or (b) borrowing on margin to go up to $1.25M portfolio and keeping the $250K mortgage?  These have two very different risk profiles to me.  I would never do (b).  I probably wouldn't do (a) either for the reasons already outlined, but I can see the logic.  It might be helpful to clarify what you're thinking here for more specific feedback.

I'm trying to understand why we are accepting of investing with our mortgage, but margin is frowned upon (even if done at reasonably safe levels).  For example

Neutral: $1,000,000 in stock equity
Good: $1,250,000 in stock equity with a $250k mortgage at 3%
Bad?: $1,250,000 in stock equity with a $250k margin balance at 1-2.5%
Real Bad?: $1,500,000 in stock equity with a $250k mortgage at 3% and $250k margin balance at 1-2.5%.  This would actually have even less risk of a margin call than the non mortgage setup. 

These all look fairly equivalent to me, so I'm wondering what the catch is if there is one.  Obviously the last one has more leverage and more risk, but seems like a fairly safe way to expand your growth in the long run.

[secondcor521]

I'm no expert and I've never done margin.  In my view, in general, investing up to 100% equities can make sense (in fact I tend to be around 96/4), but beyond 100% equities, the risk/reward ratio diverges sharply - you might get 10% gains but you're also guaranteeing 2.5% losses.

You are only guranateeing 2.5% loss on the margin amount, not your whole portfolio.
I personally do about 90/10 for stocks/bonds.

Of course.  But I make decisions on marginal/differential/delta effects, not total effects.  So if I have $1M in 96/4 vs. $1.25M composed of 96/4 plus a $250K margin invested 100% in stocks, then the $1M @ 96/4 is the same in both scenarios and I can analyze the $250K margin decision separately.  And to me, a guaranteed loss of 2.5% per year on $250K with the average chance of making 10% isn't a good risk/reward tradeoff.

I don't know what the margin ratios are for a margin call.  Even with $1M in equities, you might have gotten a margin call in March of this year.  And my understanding is that you don't get to decide what to sell; they can sell anything in your margin account.  And you get whatever tax consequences result (i.e., you realize a capital gain or loss at that point, which may or may not be what you want).

In my example, a margin call would be nearly impossible without market dropping rediculous amounts (see math below).  Most margin calls in regular times are around 25%.
https://www.investopedia.com/terms/m/margincall.asp

Real World Example of a Margin Call
Suppose an investor buys $100,000 of Apple Inc. using $50,000 of his own funds. The investor borrows the remaining $50,000 from their broker. The investor's broker has a maintenance margin of 25%. At the time of purchase, the investor's equity as a percentage is 50%. The investor's equity is calculated using this formula: Investor's Equity As Percentage = (Market Value of Securities – Borrowed Funds) / Market Value of Securities. So, in our example: ($100,000 – $50,000) / ($100,000) = 50%.

Versus in my case where I was arguing only expanding your portfolio by say 25% of your initial amount rather than 100% which is typical max.  For example, you with 100k and margin 25k would work out like this:
125,000-25,000(margin)/125k=80%.
Even if your margin investment went to 0, you would still be at 100k-25k/125k=60%, well above the 25% margin call.
You wouldn't risk a margin call until your 125k portfolio dropped to $32k, a 74.4% loss which is more than even most peoples 50% market drop estimats for big crashes.

As noted above, I don't know what margin requirements are.  If I were in your shoes, I'd call an actual broker that I thought I might work with and ask them what their requirements are, rather than rely on an Investopedia article.

I did try to find the requirements at Fidelity briefly yesterday and couldn't find them.  I also believe that the broker has the option of changing the margin requirements at any time.  I would be concerned that they would raise the margin requirements at inopportune times.  In other words, they might choose to reign in their risk at times when things look risky, exactly the time when you probably don't want a margin call.

You seem to be alluding to two different ideas:  Start with a $1M portfolio and a $250K mortgage.  Then are you suggesting (a) borrowing $250K on margin and paying off the mortgage, or (b) borrowing on margin to go up to $1.25M portfolio and keeping the $250K mortgage?  These have two very different risk profiles to me.  I would never do (b).  I probably wouldn't do (a) either for the reasons already outlined, but I can see the logic.  It might be helpful to clarify what you're thinking here for more specific feedback.

I'm trying to understand why we are accepting of investing with our mortgage, but margin is frowned upon (even if done at reasonably safe levels).  For example

Neutral: $1,000,000 in stock equity
Good: $1,250,000 in stock equity with a $250k mortgage at 3%
Bad?: $1,250,000 in stock equity with a $250k margin balance at 1-2.5%
Real Bad?: $1,500,000 in stock equity with a $250k mortgage at 3% and $250k margin balance at 1-2.5%.  This would actually have even less risk of a margin call than the non mortgage setup. 

These all look fairly equivalent to me, so I'm wondering what the catch is if there is one.  Obviously the last one has more leverage and more risk, but seems like a fairly safe way to expand your growth in the long run.

You may be responding to other people, but not to me with your comments above.  I didn't express an opinion on whether the ideas were good or bad; I just noted some factors and what I would do.  I also wanted to figure out which of these scenarios you were actually seriously thinking about, so we could give more targeted feedback.

What you seem to dismiss in claiming that those scenarios are "fairly equivalent" is (a) the risk of a margin call, (b) the risk of leverage working against you, and (c) the cash flow requirements of debt in scenarios 2 through 4.  If you have plenty of capital and cash flow to address the first and third of these, then you can probably become very wealthy without the leverage.  And if you don't, then these risks can sink you very fast.

On the face of it, 2.5% on a margin loan seems cheaper than 3% on a mortgage.  The former comes with a call risk, the latter doesn't.  Since these Wall Street guys are pretty smart and could probably find a way to loan their money to mortgage borrowers or to people wishing to invest or trade on margin, I figure they figure that they can make more money on the 2.5% margin lending than the 3% mortgage investing.  I guess that call risk makes up for the difference in rates to them.  Maybe they're right, maybe you're right.  I'd bet on them.

[EricEng]

Of course.  But I make decisions on marginal/differential/delta effects, not total effects.  So if I have $1M in 96/4 vs. $1.25M composed of 96/4 plus a $250K margin invested 100% in stocks, then the $1M @ 96/4 is the same in both scenarios and I can analyze the $250K margin decision separately. And to me, a guaranteed loss of 2.5% per year on $250K with the average chance of making 10% isn't a good risk/reward tradeoff.

So I guess to start with, would you pay off your mortgage or let it run while you invested the cash?  By the sounds of that last bit you would always pay off your mortgage.

This is more a question to those who advocate not paying off their mortgage and investing the proceeds.  As far as I can tell this is nearly equivalent return to that approach.  At the amounts I'm talking the risk of margin call is non existent, but you would be increasing your potential gains by 15-25% on average (depending on how far above the interest rate you perform).

.  Since these Wall Street guys are pretty smart and could probably find a way to loan their money to mortgage borrowers or to people wishing to invest or trade on margin, I figure they figure that they can make more money on the 2.5% margin lending than the 3% mortgage investing.

There are 15 year mortgages at 2.5% and below atm.  The loaners can't make more or less money than the 2.5% interest rate.  They just risk people defaulting.  In the case of the stocks, margin calls protect them from defaults.  Forclosure is not as safe at protecting their money they are loaning out.  I expect that is why Interactive Brokers is willing to loan as such low interest rates as it is very low risk on their end.

As noted above, I don't know what margin requirements are.  If I were in your shoes, I'd call an actual broker that I thought I might work with and ask them what their requirements are, rather than rely on an Investopedia article.

I'm also not relying on just that article.  Interactive Brokers states it is 25% for them (raised to 33.7% temporarily). 
https://www.investopedia.com/interactive-brokers-raises-margin-requirements-5079138
https://www.thinkadvisor.com/2020/09/23/interactive-brokers-raising-margin-requirements-before-u-s-election/

[Telecaster]

I'm trying to understand why we are accepting of investing with our mortgage, but margin is frowned upon (even if done at reasonably safe levels).  For example

Neutral: $1,000,000 in stock equity
Good: $1,250,000 in stock equity with a $250k mortgage at 3%
Bad?: $1,250,000 in stock equity with a $250k margin balance at 1-2.5%
Real Bad?: $1,500,000 in stock equity with a $250k mortgage at 3% and $250k margin balance at 1-2.5%.  This would actually have even less risk of a margin call than the non mortgage setup. 

These all look fairly equivalent to me, so I'm wondering what the catch is if there is one.  Obviously the last one has more leverage and more risk, but seems like a fairly safe way to expand your growth in the long run.

What you are proposing probably will work okay.   But here's the hitch as I see it.  Two hitches actually.  We view the stock market as being on an ever upward climb.   And that's true.   But the climb is really lumpy   For example, let's say you got in on the market a year after the 2000 peak.  The market continued to slide for a couple years before starting to slowing climb, only to get clobbered by the housing bust.   So ten years of paying interest for nothing. 

So how is this different than not paying off the mortgage?  A mortgage is long term, non-callable, and fixed rate.  If you look at the fine print of your margin agreement, you'll see that the broker can change the terms anytime they want.  In fact, I'll just copy this from Fidelity:

When you borrow on margin, you agree to maintain the level of margin collateral we require (which we may change in our sole discretion at any time without prior notice)...

...Some investors mistakenly believe that Fidelity must contact them for a margin call to be valid, and that Fidelity cannot liquidate securities or other assets in their accounts unless Fidelity has contacted them first. This is not the case. Fidelity may attempt to notify you of margin calls, but is not required to do so. In addition, even if Fidelity has contacted you and provided a specific date by which you can meet a margin call, Fidelity can still take the necessary steps to protect its financial interest prior to that date, including immediately selling the securities without notice to you.

One thing that kicked off the dot.com bust was brokers arbitrarily making margin calls on high flying tech stocks like JDS Uniphase.  They got nervous about too much leverage and called the loans.  A similar situation happened during the credit crunch.  Everybody needed cash so the loan terms got changed by the brokers' "sole discretion and without prior notice."

Rates are super attractive right now, but where will they be five years from now?   You have what appears to be a manageable strategy, but be aware there is non-controllable risk built in. 

[maizefolk]

The key distinction is that a mortgage is fixed rate, non-callable debt. A margin loan is both variable rate and callable. (Edit: Telecaster made this same point before I finished writing this).

So there is a significantly non-zero risk that you'll be forced to sell when the market is down because your brokerage is increasing their margin requirements and/or decides to get out of the margin business and/or decides to hike their interest rates because of all the losses they've taken when the markets dropped too fast for them to liquidate people's accounts without taking a loss.

Yes, you can show that with the current rules and with some range of outcomes the risk of a margin call is low, but the fundamental issue is that your broker can change the rules at all time, and historically they tend to change the rules in ways which are not in investors' favor during stock market crashes.

That doesn't mean it doesn't ever make sense to use leverage, but it is a qualitatively different decision from the perpetual do/don't pay off your mortgage debate because it's a different type of borrowing. So why not discuss your use of leverage on its own strengths and weaknesses instead of trying to drag in the perpetual mortgage argument?

[bacchi]

As an example, IB increased their margin requirements around election time, expecting volatility to increase dramatically.

[EricEng]

That doesn't mean it doesn't ever make sense to use leverage, but it is a qualitatively different decision from the perpetual do/don't pay off your mortgage debate because it's a different type of borrowing. So why not discuss your use of leverage on its own strengths and weaknesses instead of trying to drag in the perpetual mortgage argument?

I brought in mortgage because I agree with that concept after having been on both sides (paying off and not).  This seemed very similar to it.  So I was curious on how people differentiate the two and why they favor mortgage investing, but not margin.  I always ruled it out in the past because margin rates were 7-10% which would outpace long term returns, but I wasn't checking margin rates at other places.

So there is a significantly non-zero risk that you'll be forced to sell when the market is down because your brokerage is increasing their margin requirements and/or decides to get out of the margin business and/or decides to hike their interest rates because of all the losses they've taken when the markets dropped too fast for them to liquidate people's accounts without taking a loss.

I'm pretty sure someone like interactive broker won't just bail on margin as they have been doing it for decades.  Biggest risk I see is them increasing interest rate, which you could probably just sell and stop doing margin then as rates are usually higher when economy is stable, but it would still be at exact time of your choosing on the sale.

Still seems like if you did a small 10-25% margin of your large portfolio even if they upped the requirement to 50% along with a 50% market drop you'd be fine.  IE:
100k+25kmargin with a 50% maintance req (pretty unheard of high) wouldn't have a margin call until account value dropped below $50k, a 60% drop in market.
Maintenance req for 50%: 25k/(1-.5)=$50k
Maintenance req for 37.5%: 25k/(1-.375)=$40k
Maintenance req for 25%: 25k/(1-.25)=$33k

You could even drop it to just 10% and have a nearly 0% chance of ever seeing a margin call while still getting a nice small bump in the long term on returns.  A margin call also doesn't mean you have to liquidate your whole position.  If you just barely reach it you have to add a little or sell a little to get back in compliance.

What you are proposing probably will work okay.   But here's the hitch as I see it.  Two hitches actually.  We view the stock market as being on an ever upward climb.   And that's true.   But the climb is really lumpy   For example, let's say you got in on the market a year after the 2000 peak.  The market continued to slide for a couple years before starting to slowing climb, only to get clobbered by the housing bust.   So ten years of paying interest for nothing.

Never said you had to jump in all at once.  You could dollar cost average your way in.  Say adding 5% margin a year over 5 years?

[ChpBstrd]

I think the risks of being forced to sell at a bottom due to a margin call is the most significant issue. It's a bit like putting a panicky market timer who can change their own guidelines (i.e. your broker) in charge of your portfolio.

Reduction of this risk involves either:
     1) Keeping a pile of cash on hand to boost your account if necessary.
     2) Selecting low-volatility or hedged positions.

For the #2 strategy, you could invest in low-volatility ETFs like SPLV, USMV, FDLO, or XMLV. You could also set up a low-volatility position using options (e.g. covered call, protective put, or collar). I would prefer the options approach because it would provide more protection from a bear market. You're still getting called on your low-vol ETF even if it is only down 20%.

[MustacheAndaHalf]

I went on margin earlier this year, roughly at the level the OP suggests, for one week.  Before doing that, I planned for market drops of -30% or -50% or even -90%.  My plans all had one thing in common: accept leveraged losses as being wrong, and pay off the margin loan.  For me, I would have paid off the margin loan between a 15-30% loss, locking in the leveraged loss - but not having further leveraged losses.

The OP's level of margin looks reasonable, at 125% of equities (100k equities + 25k equities - 25k margin loan).  This year's March drop was about 1/3rd, which turns 125k into $83k ... after subtracting the margin loan, that's 58k left.

I'll also second looking at Interactive Brokers (IBKR) rather than Robinhood.  If you take out a loan between 100k and a million, IBKR charges just 1.09% for margin loans.
https://www1.interactivebrokers.com/en/index.php?f=46376

What IBKR does differently is dynamic margin calls.  They don't give you 2 days to respond, they sell first and tell you what they sold afterwards.  Another poster says they tend to pick the worst thing to sell (highest gain is highest risk, to them).  But using only 1.25x margin, you should be far away from those levels - especially if you hold index funds.

[MustacheAndaHalf]

I hadn't actually realized how sharp the drop in margin rates was at IBKR.  Their highest rate is 1.59%, but over 100k margin loans cost 1.09% ...

VTI pays a 1.44% dividend, which is enough to cover margin interest.
IBKR also has a program where you can lend your securities, and IBKR will split the profits with you.

The catch being, if someone tries to get too much of a good thing, their leverage could escalate to 1.5x ... 2x ... even 3x.  At 3x leverage, even a -25% loss will trigger a margin call (300% equities => 225% equities - 200% loan = net 25% assets, because -25% is leveraged to -75%).

But back to the key point: 1.09% margin loans seem better than Robinhood's 2.5% margin loans ... both of which beat Vanguard's 100k-250k margin loan cost of 7%.

Whichever place you pick, you'll need to apply for a margin account.  Both Vanguard and IBKR ask about your investment experience and typical investment levels.  IBKR additionally asks you to take a quiz, to show you understand it.  If your application for a margin loan is granted, your account will turn into a margin account.  At Vanguard, that meant buying stocks and going negative on your cash balance, with that negative balance automatically becoming a margin loan until it's paid off.

I found it valuable to talk to someone on the phone about what I was seeing in my new margin account.  "Is it normal to have a negative cash balance?  Does that automatically become a margin loan?  Am I in trouble on the settlement date when I have a negative balance?"  Helpful to hear those answers, before going deeper in on margin.

[bacchi]

I think the risks of being forced to sell at a bottom due to a margin call is the most significant issue. It's a bit like putting a panicky market timer who can change their own guidelines (i.e. your broker) in charge of your portfolio.

Reduction of this risk involves either:
     1) Keeping a pile of cash on hand to boost your account if necessary.

Having a pile of cash sitting around to boost your account kinda defeats the point.

     2) Selecting low-volatility or hedged positions.

It doesn't make a lot of sense but IB also increases margin requirements on option spreads.

[EricEng]

I hadn't actually realized how sharp the drop in margin rates was at IBKR.  Their highest rate is 1.59%, but over 100k margin loans cost 1.09% ...

VTI pays a 1.44% dividend, which is enough to cover margin interest.
IBKR also has a program where you can lend your securities, and IBKR will split the profits with you.

Yeah, that's kind of what I was thinking.  It basically cancels out slightly in your favor.  Then you can safely ride normal market movements at a faster rate (assuming you keep your leverage low). 

What is that securities lending thing?

[MustacheAndaHalf]

I've only been on the flip side of securities lending.
Owner) someone with 1 share of Hertz stock
IBKR) the broker who arranges the lending
me) I want to sell 1 share of Hertz short

I have no shares of Hertz, but want a short position on the belief the stock price will drop.  IBKR convinces Owner to lend their 1 share of HTZ to IBKR.  IBKR sells that HTZ share, and deposits the cash in my account.  But it also puts a -1 HTZ in my account.

For as long as I hold the short position of -1 HTZ, I will pay interest to IBKR.  IBKR then shares part of the interest payments with Owner.  Owner is getting paid to loan their securities to IBKR.

Now Hertz has dropped, and the interest is rather high, so I close my position.  I simply buy 1 share of HTZ, which cancels my -1 HTZ position.  I now have 0 HTZ, which automatically ends the loan.  The share of HTZ I just bought moves to IBKR.  I don't know if Owner ever sees the shares leave or not, but at this point the 1 share of HTZ is back in their account.

Others with more experience, feel free to chime in.  IBKR has asked me to lend securities and split the profits, but I haven't done so yet.

[EricEng]

So maybe I was onto something after all.  Apparently MMM likes the idea of Interactive Brokers Margin rates of 1% better than a mortgage.
https://www.mrmoneymustache.com/2021/01/29/margin-loan-ibkr-review/

[RWD]

So maybe I was onto something after all.  Apparently MMM likes the idea of Interactive Brokers Margin rates of 1% better than a mortgage.
https://www.mrmoneymustache.com/2021/01/29/margin-loan-ibkr-review/

Sounds like he used it to come up with funds quickly without selling shares and that a conventional mortgage will be replacing it soon.