If you're an investor, you might be able to utilize a number of your stocks, bonds, exchange-traded funds and other securities to have a loan. Securities-based borrowing is not likely to affect your credit, and might be considered a wise decision for borrowers with low credit scores who can't qualify for traditional loan options.
This kind of borrowing comes with a set of risks, however. Here's what you should know before you apply.
How Does Securities-Based Lending Work?
A securities-based loan is a type of loan that permits you to use your investment portfolio as collateral to secure loan funds. Historically, this kind of loan has only been available to high value investors, but it has become a choice for investors with modest portfolios.
Depending on the lender, you might be capable of getting a payment loan or a revolving credit line. Loan and line of credit amounts ranges from 50% to 95% from the assets used as collateral, depending on the institution and also the size your portfolio.
Once you're approved for a securities-based loan, the financial institution will place the collateral you've selected to use inside a separate, locked account. That means you will not cover the cost of any trades until you've paid the borrowed funds entirely.
If you stop making payments in your loan, the lending company can seize your collateral and sell it to extract your unpaid balance. Also, if the worth of your collateral drops significantly enough, you may be susceptible to a margin call, meaning you will need to deposit more income into your investment account. If you can't, the lending company may place some of your portfolio to pay for it.
Pros and Cons of Using Securities-Based Lending to Borrow Money
There are a few solid good reasons to consider leveraging neglect the portfolio to obtain a loan, but the risks may be excessive for some.
Pros
- Interest minute rates are relatively low. The collateralized nature of the account allows lenders to charge interest rates in the single digits, which may be a lot more appealing than personal loans and credit cards.
- You can keep your investment positions. An alternative to a securities-based loan is to simply sell off a portion of your investments. But when you don't want to lose potential future development in those positions, this kind of loan makes it so that you can hold on to them.
- It's a choice for borrowers with bad credit. Getting most kinds of loans with bad credit can be tough. However with securities-based lending, credit standards are much less stringent.
Cons
- Interest is typically variable. These loans typically carry a variable interest rate, which could fluctuate over time with market rates. If interest rates start increasing, so can the price of the loan.
- You might be subject to a margin call. If the value of your portfolio drops below a specific amount, the lender may liquidate some or all your collateral to fulfill the margin call. The only way to avoid this is to deposit more cash to your investment account. Considering you simply borrowed money, however, you may not obtain that kind of money on hand.
- Your access to your portfolio is going to be restricted. You can't make any trades on your collateral while the loan is outstanding without permission in the lender. If prices start dropping, there's nothing you can do about it.
- You may lose your portfolio. If you cannot pay back the loan unconditionally, the lending company may seize your collateral and liquidate it to recuperate the rest of the principal balance.
- There may be tax implications. If the lending company liquidates any of your assets as a result of margin call or default, you will be after tax based on IRS rules. If you've held the assets for less than annually, your gains will be taxed in the ordinary income rate. If you have held them for longer than annually, they'll be susceptible to the low long-term capital gains tax rate.
- They won't help you build credit. Unlike unsecured loans along with other forms of debt, on-time payments usually aren't reported towards the credit bureaus and for that reason won't help borrowers build their credit.
How Securities-Based Lending Impacts Credit
Securities-based loans typically don't impact your credit at all. They're easier to get than many traditional loans because they generally don't require a credit check—lending decisions are largely according to your collateral.
Also, brokerage firms typically don't report your payments on a securities-based loan to the credit bureaus. So if you're thinking of one to build your credit report, you may want to reconsider.
Alternatives to Securities-Based Lending
A securities-based loan can be tempting, particularly if your credit is less than perfect. But if you need funding now, consider other options before you decide to risk your investment portfolio.
Options include:
- Sell off a number of your portfolio. While may possibly not be ideal, selling off some of your investments may be simpler than with them to secure a loan. Make sure to consider the tax implications of this option.
- Use your credit cards. If you already have charge cards, consider using them to cover your expenses if possible. The interest rate is going to be higher, but it leaves your portfolio intact.
- Apply for a personal loan or charge card. If your credit is within decent shape, you may be capable of getting a relatively a low interest rate rate on a personal bank loan or perhaps a credit card by having an introductory 0% APR. You can get personalized credit card and loan offers through Experian CreditMatch™.
- Ask family members or friends for help. If you can't qualify for an unsecured loan or credit card having a favorable rate of interest by yourself, consider asking loved ones for a financial loan that you will pay back.
- Improve your credit. If you don't necessarily need the money at this time, consider taking time to improve your credit prior to applying for a conventional loan option. Look at your credit rating and credit history to obtain a concept of what your location is where you can make some adjustments, then do something to address negative credit items.
Take your time to think about all of your options before settling on a securities-based loan. Building credit may take time, however the long-term advantages of lower rates of interest on traditional loans are worth the effort.