M1 Finance is well-known as a no-fee, no-commission online broker. Many newer investors ask, “How does M1 make money?”
The answer is through its selection of additional products. One such product is M1 Borrow, which is the company’s margin loan program.
For more experienced investors, margin loans can be a useful tool for amplifying investment gains and expanding overall portfolio value. We briefly touched upon M1 Borrow in our M1 Finance review. Here’s what you need to know about how it works.
What is M1 Borrow?
M1 Borrow is a type of line of credit offered exclusively to investors on their portfolios. They offer highly competitive interest rates on margin loans, with lines of credit available at interest rates as low as 3.5%.
To take advantage of M1 Borrow, you’ll need to have a minimum of $5,000 within a taxable brokerage account.
Unlike traditional banks, M1 investing enrolls you automatically. Of course, you’re not obliged to take any margin, but it’s useful because other brokers require you to commit to a formal application process to obtain it.
How Much Does it Cost to Use M1 Borrow?
M1 Finance charges nothing to take out a margin loan if your account meets the minimum $5,000 balance. Interest rates are tied to the Federal Funds Rate. This rate is based on the Federal Reserve’s current approach to monetary policy, so interest rates can theoretically change every so often.
However, interest rates are practically guaranteed to be in the low single digits, so it’s a type of margin loan that far surpasses the deals offered by other brokers.
You can even sign up for M1 Plus, which is the $125 paid version of the M1 Spend account, and you’ll receive a 1.5% interest rate deduction on all margin loans.
Interest is charged at the end of each month and will be automatically deducted from your cash balance. You can also set up a payback schedule to control when you make your interest payments.
Is Taking a Margin Loan with M1 Borrow a Good Idea?
From an objective point of view, our M1 Finance review would always say that this is a solid margin loan program. On the other hand, taking margin isn’t always the best idea because you’re borrowing against your portfolio.
Margin can give you more purchasing power to magnify your gains, but if the value of your portfolio falls your losses will be magnified.
M1 offers margin loans of up to 35% of your total portfolio value. For example, if you have a portfolio of $10,000, you’ll be able to borrow a maximum of $3,500.
There’s also the maintenance amount to take into account. Most brokerages require 30% of your portfolio to consist of actual equity, and M1 is no exception. If your investments fall below the maintenance amount, you’ll get what’s known as a margin call.
A margin call is where the broker is permitted to immediately close your positions without prior warning. If this happens, there’s nothing you can do about it and you risk wiping out a sizeable portion of your portfolio.
M1 Borrow in Action
Let’s take a look at an example of how the M1 margin loan program can be used in a real investment portfolio:
Dave has $5,000 in his portfolio and he invests 100% in a stock he likes (bad idea!). He gets lucky and he doubles his money to $10,000 and sells out. Now, he decides to use M1 Borrow to further increase his buying power.
He borrows the maximum of $3,500 at an interest rate of 2% and throws the entire $13,500 into another stock he likes. His margin will already cost him $70 per month until he sells out. Again, he invests 100% in a stock he likes.
Dave immediately sees his $13,500 investment fall by 25% to $10,125. He’s already in danger of being margin called. The following day the investment falls by another 10% to $8,775, thus triggering the margin call.
His investment is sold automatically, and he now has less than his initial collateral.
Of course, if the investment had gone the other way he would have made thousands and would have been able to further increase his margin to amplify his investments.
As you can see, this is a high-risk play.
Pros and Cons of M1 Borrow
Let’s take a look at the pros and cons of using M1 Borrow to help you work out whether this investment product is right for you.
- Low interest rates
- Automatic enrollment
- Flexible repayment schedule
- No penalties for early repayment
- Easy to take out on the app
- Minimum of $5,000 needed
- Varying interest rates
- 30% equity threshold
Final Thoughts: Is M1 Borrow Right for You?
At its heart, M1 Finance’s approach to margin loans is no different from that of other popular brokers. The difference is interest rates are low and there are no application periods required to become eligible for margin loans.
Like any form of portfolio leverage, this is a tool for experienced investors. Incorrectly using leverage could blow up your account and set you back months, or even years.
If you’re interested in trying out M1 Borrow for yourself, or you want to find out more about the M1 investing platform, click on this link.