Are Value Based Loans a Good Idea?

Once reserved for the ultra-rich, equity-based lending has found a following in recent years as a popular source for financing luxury goods, real estate and small businesses, among other things. While it is touted as a great way to put your unrealized gains to work for you, investors should consider treading carefully.

What are securities-based loans?

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 available through larger banks and financial institutions, brokerage firms, or advisory firms. The interest rate is usually lower than other forms of credit and is based on the short-term index, such as the London Interbank Offered Rate (LIBOR) plus a spread determined by the amount of your loan.

The instrument through which you tap into 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 is outstanding. You can usually receive funds within days.

With a SBLOC, the lender becomes the lienholder. You can often borrow between 50% and 95% of your eligible assets, depending on the value of your holdings, types of collateral, and your credit score. You may also continue to buy, sell, and trade securities in your committed accounts, but it is important to note that loan proceeds cannot be used for other securities-based transactions, including purchases and trades. Also, SBLOCs are quite “sticky” in the sense that it is difficult to move your pledged assets to a new company once an account has been opened.

Uses of funds

Such loans provide easy access to capital and allow the borrower to avoid having to sell securities to take advantage of their funds. Examples of uses include:

Staff

  • Real estate and bridge loans
  • Tax payment
  • Tuition
  • big buys
  • Luxury goods and personal property
  • Wedding
  • Ride
  • unexpected emergencies

Deal

  • Invest in a business
  • expansion of a business
  • Short-term capital expenditures
  • Interest in a business partnership
  • Liquidity for estate planning
  • acquisitions
  • Startup Seed Financing

What collateral can be used?

Although no longer used solely by the ultra-rich, value-based lending is generally limited to those customers 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 used to secure the loan will be deposited into an account while the lender becomes the lien holder of that account.

The types of collateral your lender may allow include:

  • Stocks
  • Investment Grade Bonds
  • Treasury, municipal and government agency bonds
  • Investment funds
  • hedge funds
  • Actions
  • Exchange Traded Funds (ETFs)
  • Cash and cash equivalents as certificates of deposit

To use your SBLOC funds, you must have access to company-provided checks, wire transfer, electronic funds transfer, or ACH payments.

Advantages of Equity-Based Lending

Equity-based loans have multiple advantages for investors looking to access quick cash, including:

Lowest cost: Setup is cost-effective, with no setup fees and only the funds incur an interest charge, which is often lower than other loan options such as a line of credit, home equity and credit card.

Financial flexibility: With quick access to money, the loan is perpetual, or never due, allowing you to pay back and borrow again later as often as you like.

Tax Efficiency: These types of loans can provide a tax-efficient option to avoid capital gains that would normally result from selling your securities.

Credit Agnostic: These loans generally do not appear on the borrower’s credit report.

Disadvantages of Equity-Based Lending

There are multiple downsides to securities-based lending that investors should be aware of, including:

Regulation: There is a lack of regulatory oversight by the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA).

Increasing Rates: Depending on the type of loan taken, if interest rates increase, it could create an increase in the rates applied to your SBLOC and ultimately erode the value of our account, depending on the type of collateral in your account.

Settlement: If you default on your loan, your lender may liquidate your securities. Also, lenders may decide to liquidate these assets without notifying you.

Margin Call Risk: If the value of the investment falls below the value of the collateral, a margin or maintenance call may be forced, resulting in liquidation. Because the loan may have uneven liquidity, it may be difficult to discharge collateral quickly enough to repay the loan. If you can’t post the required collateral or additional funds within a few days of the call, your lender may liquidate your securities to satisfy you.

Potential Tax Consequences: If your assets are liquidated to cover a margin call, there could be tax consequences involved.

Bubble potential: If the loans fail all at once, investors could be trapped in a bubble. On a larger scale, such a bubble could have implications for the market, should everyone decide to sell their portfolio at the same time.

final thoughts

A boon to exchanges in recent years, securities-based lenders have generated revenue through cross-selling to wealthy customers. We recommend being careful before considering pledging your securities as collateral for vanity purchases. If your securities firm offers a SBLOC through a third-party lender, you should ask your advisor how they will monitor your account and how and when you will be notified of a collateral shortfall that could result in a margin call.

These types of loans may not be the best option for investors who are concerned about the risks and the possibility of undermining their retirement. As always, we recommend that you seek the advice of a trusted financial advisor to help you navigate the world of equity-based lending.

This material has been provided for general informational purposes only and does not constitute tax or legal advice. Although we do our best to ensure that our information is accurate and useful, we recommend that you consult a tax preparer, professional tax advisor, or attorney.
Kris Maksimovich is a Financial Advisor located at Global Wealth Advisors 4400 State Hwy 121, Ste. 200, Lewisville, TX 75056. He provides securities and advisory services as a Commonwealth Financial Network® Investment Advisor Representative, Member FINRA/SIPC, Advisor investment registered. The financial planning services offered through Global Wealth Advisors are independent and not related to the Commonwealth. He can be reached at (972) 930-1238 or at info@gwadvisors.net.
© 2022 Global Wealth Advisors

President and Founder, Global Wealth Advisors

Kris Maksimovich, AIF®, CRPC®, CRC®, is President of Global Wealth Advisors in Lewisville, Texas. Since it was formed in 2008, GWA continues to expand with offices across the country. Securities and advisory services offered through Commonwealth Financial Network®, member FINRA/SIPC, a registered investment adviser. The financial planning services offered through Global Wealth Advisors are independent and not related to the Commonwealth.

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