How Securities Based Loans Work

A securities based loan is a line of credit backed by investments in your portfolio, allowing you to access cash while keeping eligible securities invested. Because the debt is secured, these loans often have relatively competitive interest rates, although rates are commonly variable and borrowing limits depend on the investments pledged. The risk, however, is that a significant market decline could require you to repay part of the loan or provide additional collateral.

Talk to a financial advisor to discuss the pros and cons of a securities based loan in your situation.

What Are Securities Based Loans?

A securities based loan, or SBL, allows you to borrow money using eligible investments as collateral. Depending on the lender, qualifying assets may include stocks, bonds, mutual funds and exchange-traded funds (ETFs).

These loans are commonly structured as revolving lines of credit rather than one-time lump-sum loans. The lender establishes a borrowing limit based partly on the value and type of securities pledged. You can then borrow within that limit, regaining borrowing capacity as you repay the balance.

Banks and other financial institutions may offer securities based lending, sometimes through arrangements involving brokerage firms. The primary appeal is that you can access some of the value of your portfolio without immediately selling investments.

For example, suppose you own $100,000 of eligible securities but need $25,000 for a large expense. Selling investments could generate capital gains, and it would remove those assets from the market. An SBL could provide the cash instead, with the securities remaining in your account as collateral.

That benefit comes with a significant condition, though. Your borrowing capacity depends on the specific investments securing the debt. A decline in their value could cause the lender to require additional collateral or repayment.

How Do Securities Based Loans Work?

When establishing an SBL, you designate eligible securities that will secure the line of credit. The lender then determines how much it is willing to lend based on factors such as the value, liquidity and volatility of those investments.

Not every asset receives the same treatment. A lender may allow you to borrow a larger percentage against securities it considers relatively stable. Meanwhile, it may offer a smaller percentage against assets that can experience substantial price swings. Individual lenders establish their own collateral requirements and lending limits.

Once the line is established, you can generally borrow up to the available limit without selling the pledged investments. Interest accrues on the amount actually borrowed rather than the full credit line.

The value of the collateral continues to be relevant even after you borrow. If your investments decline substantially, the lender may require you to deposit additional eligible securities or cash. Or, you may have repay some of the outstanding balance.

Securities Based Loan vs. Margin Loan

Securities based loans and margin loans both involve borrowing against investments, but they generally serve different purposes.

An SBL typically provides a non-purpose line of credit secured by eligible securities. The proceeds can generally be used for expenses outside the investment account. This may include purchasing real estate, paying taxes or covering other large expenses. However, the money generally cannot go towards the purchase or carry of securities.

A margin loan, on the other hand, is brokerage credit that is usable for the purchase of additional investments. Borrowing on margin therefore increases the amount of money you have exposed to market movements. Gains can be amplified when investments rise, but losses can also become larger when prices fall.

The distinction does not remove collateral risk from an SBL. Because your investments secure the debt, falling market values can still cause the lender to demand additional collateral or repayment. If you cannot meet the lender’s requirements, you may have to sell pledged investments.

When deciding between a securities based loan and a margin loan, the appropriate option depends partly on why you are borrowing. An SBL is generally designed to provide liquidity for uses outside the investment portfolio, while margin borrowing is associated more directly with investment activity.

How to Pay Back a Securities Based Loan

Repayment requirements for a securities based loan depend on the specific lender and loan agreement. Because an SBL is generally a revolving line of credit, you may have flexibility over when you repay principal as long as you continue meeting the lender’s requirements.

Interest charges do apply but only on the outstanding balance. If you have a $200,000 credit line and borrow $50,000, interest would generally apply to the $50,000 you are actually using.

Rates may be lower than those available with some forms of unsecured borrowing because investments secure the debt. But SBLs commonly have variable rates. As benchmark interest rates change, your borrowing costs can rise or fall.

A borrower therefore needs to consider more than the initial rate when evaluating SBLs. The length of time the debt remains outstanding, possible rate increases and changes in the value of pledged investments can all affect the eventual cost and risk of the loan.

Risks of Securities Based Lending

The central risk of an SBL is that the investments securing the loan can decline in value. If the collateral no longer provides enough support for the outstanding debt under the lender’s requirements, you may need to respond quickly.

The lender could require you to add eligible assets or repay part of the balance. If you cannot meet those requirements, the loan agreement may permit the lender to sell pledged securities. You may have limited control over which investments are sold or when the sale occurs.

A forced sale during a market decline can be particularly damaging. You may have to sell investments after they have fallen in value instead of holding them while waiting for a possible recovery. Selling appreciated investments could also create capital gains and a corresponding tax liability.

Variable interest rates create another risk. Borrowing may initially appear inexpensive, but a higher benchmark rate can increase the cost of carrying the balance. A borrower could therefore face higher interest expenses at the same time that declining markets reduce the value of the collateral.

These factors make the amount borrowed particularly important. Using only a modest portion of available credit leaves more room for the portfolio to decline before the lender’s collateral requirements become an issue. Borrowing close to the maximum can leave substantially less room for market volatility.

When a Securities Based Loan May Be Used

An SBL can provide short- or intermediate-term liquidity when an investor does not want to sell portfolio assets immediately. They may use proceeds for a real estate purchase, tax payment, business expense or another major financial need permitted under the loan agreement.

Borrowing can also postpone a taxable sale. If selling appreciated securities would generate capital gains, accessing cash through an SBL avoids that immediate transaction. An SBL does not necessarily eliminate the tax, however. In some scenarios, it may be necessary to sell securities to repay the debt. A lender-directed sale could also create taxable gains.

The strategy generally becomes riskier as the amount borrowed increases relative to the collateral. The composition of the portfolio matters as well. A credit line backed heavily by volatile securities can react more sharply to market declines than one supported by assets with more stable values.

An SBL therefore involves both borrowing and investment risk. It’s necessary to weigh the ability to obtain cash without selling securities against interest costs, collateral requirements and the possibility of an unwanted sale.

Bottom Line

A man with his head in his hands, looking at his laptop.

A securities based loan allows you to borrow against eligible investments instead of selling them to raise cash. This can provide access to liquidity while keeping your portfolio invested, but the debt remains tied to the value of the pledged securities. But falling markets, variable interest rates and lender-required sales can increase the cost and risk of borrowing.

Personal Lending Tips

A personal loan can be a great way to access cash, especially if you use it for something that adds value like home updates or educational expenses. But before you borrow, make sure you know exactly what that money will cost you.
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