margin from brokerage account to prepay mortgage

[Fred Stevenson]

Hey everyone, I have a checking account I use to manage my rentals and other business expenses. I have positive cashflow on all my rentals so my balance in this checking account is accumulating but earning zero interest. My initial plan was to keep accumulating savings in this checking account until I have saved enough to pay off one of my rental mortgages with enough left over to handle any unexpected maintenance, repair issues, or vacancies that may come with this COVID crisis.  It will take me 12-18 months to get to these levels.  In addition, I also have an income from my W2 job that I use for investing (stocks, private equity, rentals).  

I have access to a large line of credit through a margin account with my broker. I can borrow up to 50% of my portfolio value at 1.5% over prime so right now my variable rate is 1.75%. So my question is does it makes sense to take out a loan from my margin account (no fees) at 1.75% variable interest to pay off one of my 30 year fixed rental mortgage loans which has a a 30 year fixed rate of 4.5% interest. And then take a portion of my checking account balance and transfer it over to the margin account to reduce that balance in half. Checking account balance would also be reduced in half. I like this idea much more than getting a HELOC because the rate is much lower, no closing costs, and no financial colonoscopy applications to fill out. I would never max out my margin account as I don't ever want to be subject to a margin call.

I'm having a hard time coming up with reasons as to why this isn't a good idea, other than opportunity costs if I could be using the margin for other investments that would generate a much higher return than just paying down a mortgage that has a 4.5% rate. I have access to enough margin, though, that I could still utilize it for other investments if opportunities present themselves.  could also move it into a money market account with my discount broker and earn like .1%  . The idea of letting my money accumulate in a checking account at zero percent seems absurd.  Maybe the idea of paying off any of the mortgages early is also dumb, but one thing this COVID crisis has taught me, is that I would have a lot more piece of mind, if I knew that at least half of my rentals were paid off so I could absorb a loss of rents for a long period of time if it comes to that.  So far, all my tenants are paying, but this pandemic has made me question a lot of my previous ways of thinking. 

Any thoughts would be appreciated. 

[Andrew C.]

A couple points I have about this post and a major flaw in your logic as I see it.  I'll start with the most glaring, again - as I see it, so don't take this as a personal attack if I'm direct. 

     1) You said in part, "...one thing this COVID crisis has taught me, is that I would have a lot more piece of mind, if I knew that at least half of my rentals were paid off so I could absorb a loss of rents for a long period of time if it comes to that".

You are talking about paying off a 4.5% loan (which you have already qualified for and paid closing costs, etc, for) with CASH (Hard-earned, or cash borrowed at a slightly lower rate).  Remember in a crisis and downturn, CASH is KING and is NOT the time to try to convince others to lend you their money because you spent all of yours and you want more liquidity!  I'm willing to bet your broker could reduce your margin limit without any notice or consultation with you beforehand.  

Keep the historically VERY low mortgage rate. Also, you could likely refi your mortgage for an even lower rate right now. I refid several rental properties in December for 3.75% and 3.375% NOO / Investment SFR in CA. - Cash IS the peace of mind. In the the last recession 2009+ I pulled $50K from a HELOC and paid the interest cost on money I did not immediately need for the peace of mind of knowing they could not reduce borrowing limit any further. I'm assuming the cash in hand in large amount you are inferring could withstand some pretty lengthy vacancy periods. Also, remember you're not likely to get Zero rent, but perhaps reduced rent/partial payments, etc, and hopefully you already have security deposits from tenants.

     2) Earning .1% vs 0% is basically insignificant to me (my opinion) and I would rather have it totally liquid in the checking account or similar.

     3) Everyone's goals are different, but if you are planning to continue to invest and reinvest, then 4.5% is cheap money and you should be using your cash (beyond reserves that you are comfortable with) and margin money if it's that cheap to seek the higher returns based on your risk tolerance.  

4) If, you are truly NOT concerned with cashflow issues/vacancies, etc and your #1 priority is to save/reduce every dollar of interest expense, then yes, use the cash to paydown any and all debt that incurs interest. What your are describing is much like the trend of using HELOCs but keepno cash in your checking accounts, and pay/borrow from the HELCOs each month (I forget the name of it), but in the end you're only talking about saving one month's interest on ALL your income. If you have $5K/mo coming in and you paydown the HELOC by $5K then turn around and borrow/spend $5K on your monthly bills, its negligible savings based on average daily balance that the interest expense is based on. You have to be very disciplined (and you may be, sounds like you are) for this to pay off for the average person. 5) Ultimately, you seem to be expressing concern over cashflow due to vacancies, however with cash in hand, you can overcome those, I'm assuming, with your W2 income, margin options and other assets as you have described. You've already done the hard work, got the inital 4.5% loan on the rental, either refi that (and take out more cash) or hold tight with your cash.

These are my suggestions.  As I said everyone's goals, outlook and risk tolerance is different, but one thing typically remains, CASH is KING, especially in a crisis market and recession.  

If I made wrong assumptions, please correct me or add more thoughts, again, nothing personal just my OPINION (as uninformed about your situation as I am).   

Best of Luck!

Andrew