A securities-backed line of credit is a credit facility that uses as collateral a bundle of securities that you own. You can then borrow and repay against this credit at will in the same way that you can with a credit card. If you want to close the account or if the value of your securities drops, the lender will ask you to repay your outstanding loan in full. If you cannot, it will sell the underlying securities for payment. This settles the debt so long as those assets have enough value to cover the debt, otherwise you will still owe the remaining balance. You should speak to a financial advisor before deciding to take out a line of credit in this way.
A Securities-Backed Line of Credit Defined
A securities-backed line of credit or SBLOC, is a revolving line of credit that you establish based on underlying assets in an investment portfolio. It can be extended by just about any financial institution, from a brokerage or advisory firm to a traditional bank.
When you establish an SBLOC, you specify a bundle of securities that will act as collateral for the loan. Generally speaking, lenders require that you use mainstream, relatively liquid assets for this collateral, such as stocks, bonds, ETFs and mutual funds. Every lender will have different requirements for this. While some may accept more unusual assets like derivatives or futures contracts as collateral for a loan, this is rare.
The maximum amount of your loan will be based on the nature and value of the securities that you stake as collateral. This, too, will differ between lenders. Lenders assign different weights to different assets, with a particular emphasis on the potential volatility of the underlying asset. For example, a lender will typically let you borrow more against a stable Treasury bond than a volatile stock portfolio.
Most lenders will let you borrow between 50% and 95% of the sum value of your collateral. So, for example, say you stake a portfolio of stocks worth $100,000 as collateral for a securities-backed line of credit. Your lender might then allow you to borrow up to 75% of their value, giving you a maximum line of credit worth $75,000.
Most lenders also have set minimums, requiring both a minimum line of credit and a minimum initial withdrawal on that line of credit. It’s common for lenders to offer SBLOC loans with a $100,000 minimum line of credit and a $5 million maximum.
How Do You Use a Securities-Backed Line of Credit
An SBLOC is what’s known as a revolving line of credit. This means that at any given time you can borrow money up to the contract’s maximum value, in the same way that you can continuously borrow and make payments with a credit card. This is as opposed to a loan, which you take out and repay once.
When you hold a securities-backed line of credit, you pay interest on any currently outstanding debt in the account. Again, like with a credit card, you do not pay interest on the maximum value of the credit line, just the amount you currently owe. Typically lenders will calculate this interest on a monthly basis.
This is a category of loan called a “non-purpose loan.” This means that you do not have to discuss or disclose how you plan on spending the money with your lender. You cannot use the money from an SBLOC to purchase or trade securities or make other forms of regulated investment, but otherwise, you are free to spend it as you see fit. Common uses for an SBLOC are home renovations, medical bills, vacations and travel. Another popular use is debt restructuring because you may be able to get more favorable terms with a line of credit than you currently have.
The idea behind a securities-backed line of credit is that it allows you to access the cash value of your investments without having to sell these securities. This lets you keep your money invested, so you don’t lose out on long-term growth and income payments and lets you avoid capital gains taxes because the IRS does not tax loans. In exchange, you pay interest on the loan, which can often be less than you would have lost in taxes and opportunity costs.
Risks and Maintenance Calls
As the Securities and Exchange Commission wrote on the issue:
“SBLOCs are loans that are often marketed to investors as an easy and inexpensive way to access extra cash by borrowing against the assets in your investment portfolio without having to liquidate these securities. They do, however, carry a number of risks, among them potential unintended tax consequences and the possibility that you may, in fact, have to sell your holdings, which could have a significant impact on your long-term investment goals… If the value of the securities you pledge as collateral decreases, you may need to come up with extra money fast or your positions could be liquidated.”
What the SEC is referring to here is a maintenance call and it is a very serious risk.
When you take out an SBLOC, your lender sets the line of credit based on the value of the assets you stake as collateral. In our example above, say, if you post a portfolio worth $100,000, your lender might extend a line of credit worth $75,000. This would be a 75% advance rate. This system can work well so long as the value of your portfolio continues to grow or even remains stable.
However, if the value of your collateral falls to a point where it is “no longer sufficient to support your line of credit,” your lender will issue what’s known as a maintenance call. We place this phrase in quotes because it is the standard language used by lenders and the definition of “no longer sufficient” can differ based on the lender and the individual contract.
In a maintenance call, you must do one of two things: post additional collateral to bring the value of your portfolio back up to its advanced rate or repay the balance on your loan in full. You typically have no more than two or three business days to do this. The time crunch alone creates risks independent of financial concerns since you could default on a maintenance call without even knowing it just by being off e-mail for 48 hours.
If you fail to meet a maintenance call your lender will liquidate the collateral assets to repay the current balance on your loan. Not only will this defeat the entire purpose of taking out an SBLOC, but it means that your lender will sell these assets when they have lost value. In addition, if your assets are not enough to repay what you owe, you will still be responsible for any remaining balance.
The Bottom Line
A securities-backed line of credit is a revolving line of credit that you take out using a bundle of securities as collateral. They tend to be relatively inexpensive loans and can be useful to the right investor but be careful with them. In a volatile market, they can be very high risk. You may want to talk to a professional before deciding to move forward so that you make an informed decision.
Tips for Borrowing From Your Investments
- A financial advisor can help you build a comprehensive retirement plan, which should be created before borrowing from your nest egg. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A line of credit might sound technical, but in fact, it’s one of the most common forms of borrowing in the United States. Let’s take a look at what happens with these products and why you probably have one in your pocket right now.
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