Once reserved for the ultra-wealthy, securities-based lending found a following in recent years as a popular source for funding luxury items, real estate and small businesses, among other things. While promoted as a great way to put your unrealized gains to work for you, investors should consider treading carefully.
What Is Securities-Based Lending?
Securities-based lending is the practice of borrowing money while using securities held in your after-tax investment accounts as collateral. Generally, these types of loans are made available by the larger banks and financial institutions, brokerages or advisory firms. The interest rate is typically lower than other forms of credit and is based on the short-term index, such as London Interbank Offered Rate (LIBOR) plus a spread determined by your loan amount.
The instrument through which you tap the value of your securities is called a securities-based line of credit (SBLOC), which allows you to borrow money and make interest-only payments while the loan remains outstanding. Usually, you can receive funds within a matter of days.
With an SBLOC, the lender becomes the lienholder. Often, you can borrow 50%-95% of your eligible assets, depending on the value of your holdings, types of collateral and your credit score. You can also continue to buy, sell and trade securities in your pledged accounts, but it is important to note that the loan funds cannot be used for other securities-based transactions, including purchasing and trading. Additionally, SBLOCs are fairly “sticky” in that it is difficult to move your pledged assets to a new firm once an account has been opened.
Uses for Funds
Such loans provide easy access to capital and enable the borrower to avoid having to sell securities to tap their funds. Examples of uses include:
- Real estate and bridge loans
- Tax payments
- Large purchases
- Luxury goods and personal property
- Unexpected emergencies
- Investing in a business
- Expanding a business
- Short-term capital expenses
- Interest in a business partnership
- Liquidity for estate planning
- Startup seed funding
What Collateral Can Be Used?
Though not used solely by the ultra-rich anymore, securities-based loans are generally limited to those clients with significant capital and high net worth. Your lender will determine the value of your loan based on the value of your investment portfolio. You would then execute an SBLOC contract that specifies the maximum amount you can borrow. When approved, the securities …….