Borrowing Against Your Mutual Funds

THE Securities and Exchange Commission not long ago repealed a long standing ban on using mutual fund shares as collateral when you borrow money from a stockbroker. That means you now can use your mutual funds to get a personal loan from your broker or to buy securities on margin.

Should you take advantage of this opportunity? Probably not if you are a conservative investor who likes to buy steady and sound securities and just put them away in a safe deposit box without trading them. But if you have a high tolerance for risk, margin buying can increase your potential rewards.

The margin requirements vary from time to time, but in mid 1989 to borrow $4,000 to buy stocks, you would need to pledge fund shares worth at least $2,000. To borrow $2,000 as a personal loan, you would have to put up $4,000 in such shares. Either way, you would pay a variable interest rate, usually one half to two and a half percentage points above so called broker loan rates. You do not have to make regular payments on the interest or the principal. You can repay whenever you want, just as long as the market value of the fund shares you pledge as collateral remains above a certain percentage of the loan amount. Usually it's 30% or 35%.

As a margin buyer you will be at greatest risk when interest rates are rising. That means you will have to pay higher rates on your loan. Also, the value of securities tends to fall at such times, so you may get a margin call from your broker and thus have to put up additional collateral. The good news is that mutual funds are less volatile than many stocks and bonds. When markets turn down, fund shares are not likely to drop dramatically in price and trigger a margin call.