How does a margin account help with debt consolidation?

Question

I have a trading account with TD Ameritrade and I also upgraded to a margin account. I was reading through their materials and they state that a margin account can help you consolidate debts and move high interest debt to a lower interest.

How is that possible? I intend to use margin to buy stocks and, as far as I know, that's the only thing I can use it for. It's not like I can withdraw that money and then pay off debt with it, right?

What am I missing here?

UPDATE: I do not have debt to consolidate. I do not intend to use it for that. In fact, I may not use the margin at all, I just need to be approved for it to trade option spreads. I only posted the question because I think it was an interesting part of their pitch to open a margin account.

Answer 1

A margin account is effectively debt that is secured against your investments. In general, debt is the cheapest when it is secured against your assets [ie: the lender has the legal right to liquidate your assets to cover off your debt, if you are unable to make payments].

For many people, the most common form of secured debt is a mortgage secured against your house. There are a lot of legal protections for lenders who lend money for home purchases across most jurisdictions, and this allows the interest rates offered to typically be the lowest rates available to the average consumer. Remember that this cheap interest rate does come at a cost - the risk of your residence if you fail to make mortgage payments! [Side note: student loans being cheap is typically related to the fact that they are not dischargeable on bankruptcy, so again the protections offered to lenders can make for attractive rates, with an often-overlooked risk to the borrower!].

In the event that you have unsecured debt [like a personal loan, or a credit card], it may be possible to consolidate that debt with a payment plan and an assigned lower rate. Even without having security available, there can be benefits in this consolidation [seek advice on that matter from an expert if you are in that position]. To the extent you can attach security to that consolidated debt, your interest rate will drop even lower. For example, it may be beneficial to increase the debt secured against your house, either as a 2nd mortgage or a Home Equity Line Of Credit [again - at the increased risk of putting your house in potential future danger of liquidation].

Now to your question on using a margin account for this purpose: To the extent that other forms of security are not available to you, you may be able to effectively secure your investments against your borrowings, and achieve a lower rate than what would be possible with a personal loan. Whether this is wise would depend on a lot of factors. Keep in mind that a margin account will require you to keep a certain amount of investments with the broker [which is their security], so this isn't something that would work purely as a loan.

As an example of how this might work: if you had, say, $50k with a broker, you might be able to open a margin account, borrow $20k, and pay off some other outstanding debt you had. Your broker still maintains the right to liquidate your assets to cover off this $20k in borrowed funds under various circumstances [like, your $50k in assets drops significantly in value, so they become less certain that they will be able to cover themselves off against losses if your assets drop further].

Answer 2

A Special Memorandum Account (SMA) is one that is used to calculate the Reg T requirement in a margin account. If positive, it represents a line of credit for buying additional securities or withdrawing cash. First, some basics first on margin borrowing.

If your margin rate is 50% (broker same as Reg T), you can buy $10k of securities with $5k.

If your maintenance requirement is 25%, your threshold for safety is 4/3 the debit balance which in this construct is $6,667.

Now suppose your position appreciates to $12k. For SMA purposes, you now have a margin requirement of $6k which means that you have generated $1k of SMA and $2k of Buying Power which means that you could withdraw $1k cash or buy $2k more of stock.

If your broker's margin interest rate is lower than the rate you are being charged on your debts, then this is a viable approach. However, you have to be cognizant that if you withdraw cash (SMA), your debt to equity ratio gets worse and your margin percent decreases, putting you closer to the maintenance requirement, making it easier to get into trouble if the value of your securities drops (margin call).

I don't know Ameritrade's current margin interest rate but in the past, they have usually been high. If you decide to go down this road, consider Interactive Brokers which has one of the lowest margin rates.

Answer 3

I intend to use margin to buy stocks and, as far as I know, that's the only thing I can use it for. It's not like I can withdraw that money and then pay off debt with it, right?

You absolutely can withdraw the money and pay off debt with it. With many brokerage accounts, you can take a margin loan merely by making a wire transfer that you cannot cover in any other way.

Here's an example of sending a wire transfer from a brokerage account that has about $2,900 in cash but can take a margin loan of around $980,000 or so. To take the margin loan, you would just make the wire transfer: