Could a Securities – Backed Line of Credit Be Right For You?
August 30, 2021
Have you ever needed cash but didn’t want to sell any of your investments and have to pay taxes?
A securities-backed line of credit (SBLOC) could be a good solution.
SBLOCs are loans that allow you to access cash by borrowing against the assets in your investment portfolio as collateral. Because there is collateral pledged for the loan, interest rates tend to be lower than a traditional loan. Unlike a traditional term loan, most types of SBLOCs do not have a stated maturity or fixed repayment schedule – they offer much more flexibility. In some ways, SBLOCs are similar to home equity lines of credit, except of course they involve using your securities as collateral instead of your house. Additionally, SBLOCs are non-purpose loans. Money from an SBLOC does not have to be used for a specific purpose; it can be used for virtually anything, with the major exception being that the money cannot be used to purchase or trade more securities.
So how does an SBLOC work? Many firms offer SBLOCs these days – some firms only offer them to clients that have an investment account in-house, but other firms will offer SBLOCs to investors with accounts at outside institutions. The lender will run a risk-analysis on the investment portfolio to determine the maximum percentage of the portfolio they are willing to lend. Generally speaking, the more diversified a portfolio is and the higher the percentage of fixed income, the higher the maximum loan amount will be. Typically, a lender will be willing to lend anywhere from 70-80 percent of an account’s value.
There is of course risk involved with SBLOCs. If the value of your securities declines to a point where it is no longer sufficient to act as collateral for the loan and support your line of credit, you will receive a maintenance call. When this happens, you must post additional collateral or repay the loan in full. If you are unable to add collateral or repay the loan, the lending firm can liquidate your securities and keep the cash to satisfy the maintenance call. This means that your investments are at risk of being sold at a time when they have less value.
When might an SBLOC be a good idea for an investor? Of course, every case is unique and there are any number of reasons why someone might choose to use an SBLOC. Elon Musk, for example, uses SBLOCs all the time to avoid selling his Tesla shares, thus giving up his voting power and control of the company. Most people don’t need to worry about this though. A more common example would be using an SBLOC to access cash without selling securities and paying capital gains tax. This is especially helpful if you need cash in the near-term but haven’t held your investments long enough to reach long-term capital gains status. Using an SBLOC, you can get the cash you need, wait until your investments reach long-term capital gains status, then sell them to repay the loan. The tax-savings can significantly outweigh the cost of interest on the loan. Another appropriate time to use an SBLOC could be for a down payment on a new house. If you are buying a new house but aren’t in the position to wait until your old house sells, you can use an SBLOC to get cash for a down payment. Then when your old house sells, use the proceeds to pay off the loan, and avoid liquidating your investment portfolio and paying capital gains tax.
Be aware that SBLOCs are just one type of securities-based lending offered to investors. Other types include margin and stock-based loan programs. If you think an SBLOC might be right for you, speak to a financial advisor to learn more.
