A credit line backed by securities in your nonretirement portfolio can offer a powerful, flexible source of liquidity to help meet your goals.
When you have substantial investment assets, you may be able to borrow against their value to accomplish goals without upending your wealth management plans. Such debt can unlock enormous strategic potential—as long as you use it carefully.
Imagine, for example, that you needed $500,000 to seize a real estate opportunity, fund a short-term business expense, or cover an unexpected tax bill. Selling investments to raise the money could trigger capital gains taxes and undermine your portfolio's growth potential. Using your assets as collateral for a line of credit, on the other hand, could give you ready access to the cash you need, without disrupting your portfolio or tax plans.
To be clear, securities-based lines of credit come with unique risks, including the possibility that your investments could be liquidated to cover your outstanding debt, so it's important to understand how such arrangements work. Here are some things to know before considering such an arrangement.
Offered through a bank, a securities-based line of credit allows you to borrow against the value of stocks, bonds, and other assets in your nonretirement investment portfolio. (Assets in a tax-advantaged retirement account cannot be used for securities-based lending.)
Credit lines are based on the value and type of assets in the portfolio, with lenders typically advancing sums calculated as a percentage of the pledged assets. For example, a lender may accept 70% of the value of stocks, mutual funds, and exchange-traded funds (ETFs) and more than 90% of the value of certain Treasury securities and cash equivalents. Though a wide variety of assets can be considered as collateral, stocks that trade for less $10 a share may not qualify, nor will leveraged ETFs or those having a high concentration of one or a few stocks.
Once your assets are pledged as collateral, they'll be held in a separate account at a broker-dealer. The lender wants to monitor the account and restrict its use to make sure that loans are properly collateralized and can be paid back.
If this sounds a little like a margin loan, that's because they are similar, though with an important distinction: You can use a securities-backed line of credit for just about anything except to buy more securities or pay down a margin loan.
Securities-based lines of credit also typically have a higher initial advance requirement than a margin account. For example, a bank that offers a $100,000 line of credit may require the borrower to take an initial draw of $70,000 upon establishing the line. After that, you can tap the line of credit whenever you wish, up to a maximum amount based on your collateral and the lender's rules, during the draw period.
A key advantage of a securities-based line of credit is that it generally costs nothing to set up. Typically, there are no application fees, loan origination fees, annual costs, or early repayment penalties. But, lenders can assess a late fee for not paying back the loan per the loan agreement.
Lenders typically charge variable interest rates that are based on the value of the pledged investment portfolio. Many investors decide to pledge a large portion of their investment account to get the best rate—lenders typically lower the cost of borrowing for greater asset amounts pledged. Using a small portion of the pledged amount can also reduce the chance of a bank demand—see below. Interest on the loan amount typically accrues daily and is payable on a monthly schedule. Accrued interest charges are tacked onto the loan, in addition to any late fees, if unpaid.
This type of borrowing may be convenient and cost-efficient, but it's still debt and should be handled with care. Be aware of two risks in particular:
| Investor A | Investor B | |
|---|---|---|
| Pledged amount | $200,000 | $1,000,000 |
| Borrowed | $170,000 | $170,000 |
| Pledged amountafter 30% portfolio loss | $140,000 | $700,000 |
| Bank demand to replenish pledged assets | $30,000 | $ - |
SCFR. For illustrative purposes only. Individual situations will vary. Hypothetical scenario where the bank demand for additional collateral is based on meeting the minimum requirement that the pledged amount exceeds the outstanding loan amount. The bank at any time could sell the assets to satisfy the loan obligation.
Securities-based lines of credit tend to work best for investors who are savvy about the markets and won't get caught off guard by a bank demand. The best use cases are usually short-term, given the potential for market swings and the obligation to payback accrued interest. Having a financial backstop for your debt—say, if you expect to receive a bonus later in the year or plan to sell a piece of property—also helps. While paying just the interest alone will get you by, you may want to reduce the debt by paying down the principal.
Also, keep in mind that any gains you make from having your pledged assets invested in the market could help offset the interest costs of the loan. Of course, the opposite is also possible if the value of the portfolio declines, so it's important to consider both the best- and worst-case scenarios when comparing borrowing options.
As long as you understand the risks, securities-based lending can offer many advantages for the right investor. It may provide needed liquidity without the need to sell assets and could mean tax savings in the process. Knowing it's there, and having it ready, can be a valuable asset in and of itself. Speak to your Schwab financial or wealth consultant to discuss lending strategies that make sense for your unique goals.
As long as you understand the risks, securities-based lending can offer many advantages for the right investor. It may provide needed liquidity without the need to sell assets and could mean tax savings in the process. Knowing it's there, and having it ready, can be a valuable asset in and of itself. Speak to your Schwab financial or wealth consultant to discuss lending strategies that make sense for your unique goals.
As long as you understand the risks, securities-based lending can offer many advantages for the right investor. It may provide needed liquidity without the need to sell assets and could mean tax savings in the process. Knowing it's there, and having it ready, can be a valuable asset in and of itself. Speak to your Schwab financial or wealth consultant to discuss lending strategies that make sense for your unique goals.