3 Ways to Borrow Against Your Assets
Debt often gets a bad rap. But when managed responsibly, it can help you achieve your financial goals. In fact, the more assets you have, the more lending solutions you may have at your disposal.
Clients who have built up their net worth—whether in their homes or investment portfolios—could have broader borrowing options by using their own assets as collateral. But doing so exposes those assets to increased risk, so you've got to have the fortitude and investment knowledge to manage such debt effectively.
Let's take a look at three asset-backed lending solutions—and under what circumstances they might be most appropriate.
1. Home-equity line of credit
What it is: A home equity line of credit (HELOC) is a revolving line of credit, typically with a variable interest rate, collateralized by the equity in your home.
Generally, a HELOC has a 30-year term consisting of a draw period and a repayment period. The first 10 years are the draw period, where you can borrow as much as you need—whenever you need it—up to the limit established by the bank. Typically, during this time, you must make scheduled interest payments but have the option to pay toward the principal. Once the line enters its repayment period, however, you'll owe principal and interest for the remaining 20 years.
When to use it: Although you can use a HELOC for many purposes, it's particularly well-suited for:
- Home improvements: HELOCs are an attractive financing option if you're thinking about upgrading or you have to make necessary repairs to your property.
- Major purchases or expenses: A HELOC can be a great way to fund a major purchase or cover a large expense. Even if you don't have an immediate cash need, establishing a HELOC can be a great way back up your emergency fund.
- Debt consolidation: Interest rates on HELOCs may be lower than those charged by credit cards and personal loans, which can be helpful if you want to consolidate debt and reduce borrowing costs. However, because a HELOC is secured by your property, you should have a solid payoff strategy before you consolidate higher-interest-rate debt, since you are collateralizing your home.
P.S. Lenders need time to process a HELOC application because it requires a home appraisal and an underwriting review of credit and income, which can take weeks. Because of the time involved, it's best to open a HELOC well before you need the funds.
2. Margin
What it is: Just as a bank can allow you to borrow against the equity in your home, your brokerage firm can lend you money against the value of eligible stocks, bonds, exchange-traded funds, and mutual funds in your portfolio. Margin loans typically require a minimum of $2,000 in cash or marginable securities and generally are limited to 50% of the investments' value. Interest rates vary depending on the amount being borrowed but tend to be lower than unsecured lending options such as credit cards.
When to use it: Funds borrowed on margin are usually used for:
- Additional investments: Active traders may establish a margin account as a way to take advantage of a trading opportunity when they don't have adequate cash on hand. If you use the funds to purchase investments that generate taxable income—including interest, nonqualified dividends, and short-term capital gains—you may be able to deduct the interest paid if you itemize your deductions. However, if the value of your margin account falls below the maintenance requirement—the minimum dollar amount that you must maintain in the margin account once you've tapped the funds—your brokerage will issue a maintenance call, which requires you either to deposit more money or marginable securities or to sell some of the assets held in your account.
- Short-term liquidity needs: As with any line of credit, you can draw from and replenish a margin account for any reason, not just purchasing securities. A margin loan is a ready source of credit that may be used as a short-term loan for any need—and unlike a HELOC, there's no lengthy application process. But I can't stress enough the importance of moderating your borrowing. If you borrow too much and your portfolio's value declines before you repay the money, you could face a hefty maintenance call—or a large tax bill if appreciated securities are sold to meet the maintenance requirement.
P.S. It's important that the assets in your account are diversified. If you're overly concentrated in a particular investment, you could quickly find yourself below the required maintenance threshold if that investment declines considerably.
3. Securities-based lines of credit
What it is: Similar to margin, a securities-based line of credit offered through a bank allows you to borrow against the value of your portfolio, usually at variable interest rates. Assets are pledged as collateral and held in a separate brokerage account at a broker-dealer. Unlike margin, these nonpurpose credit lines may not be used to purchase securities or pay down margin loans, nor can the funds be deposited into any brokerage account. Such lines of credit also tend to require more borrowing than a margin account. For example, a securities-based line of credit for $100,000 may require you to take an initial minimum advance of $70,000 upon establishing the line.
When to use it: Because of the potential large initial advance requirement that may apply, a securities-based line of credit is best for:
- Bridge financing: We typically see a securities-based line of credit used for something that would otherwise be a short-term loan. For example, clients who wish to buy a new home before they've sold their current one have found that this type of credit line can provide a useful bridge between the two transactions.
- Liquidity: When you need quick access to cash but don't want to sell your investments—which can trigger capital gains taxes—a securities-based line of credit could be a solution. Because of the high initial advance requirement, it's best to establish this type of credit line close to when you have an immediate cash need, such as a significant tax bill. Once you take the initial advance, however, you can use the credit line for smaller liquidity needs going forward.
P.S. A securities-based line of credit from a bank is subject to a high degree of risk, which you should be sure you understand before applying. Should the market value of the pledged collateral decrease, the bank may demand immediate repayment of outstanding obligations or require you to deposit additional cash or securities to the pledged brokerage account in order to avoid the sale of pledged assets. Pledging diversified assets can help reduce this risk. Be that as it may, you should keep an eye on the value of your pledged assets—and have a backup source of funds in the event of a demand.
Have an endgame
Margin and bank-offered securities-based lines of credit, in particular, are best suited for those savvy about the markets. You need to know how much risk you're taking on—and be vigilant about managing that risk.
What's more, it's crucial to develop a repayment strategy because unlike, say, a traditional mortgage, asset-backed loans generally have a more flexible repayment schedule. And whatever you do, try to pay more than just the interest due each month.
- Home equity line of credit
- Margin loan
- Bank-issued securities-based line of credit
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Assets used as collateral>Home equity line of creditReal estate, including your primary residence and second home>Margin loanEligible securities in most nonretirement accounts>Bank-issued securities-based line of creditEligible securities, as determined by the bank, held in a separate pledged brokerage account>
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Minimum collateral requirement>Home equity line of creditEstablished by the lender and typically based on the requested line amount and the associated home value>Margin loanTypically, $2,000; some brokers may require more>Bank-issued securities-based line of creditVaries; many lenders require a $100,000 or more minimum loan value of collateral>
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Borrowing limits>Home equity line of creditA percentage of the appraised value of the home minus the mortgage value determined by the lender>Margin loanTypically, 50% of the assets' value>Bank-issued securities-based line of creditBased on the loan value of eligible pledged securities, which is typically up to 70% of their current market value; bank may require a large initial advance>
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Maintenance requirements>Home equity line of creditN/A>Margin loanTypically, 30% of the assets' market value (below which you may face a maintenance call)>Bank-issued securities-based line of creditVaries; for example, some banks require the collateral to have a loan value equal to or exceeding the greater of $100,000 or the amount of the outstanding loans (below which you may face a demand for repayment)>
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Term>Home equity line of creditTypically, a 10‐year draw period followed by a 20‐year repayment period>Margin loanRevolving line of credit, meaning no set draw or repayment periods>Bank-issued securities-based line of creditTypically, a revolving line of credit>
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Approved uses>Home equity line of creditAcceptable for most purposes, but check with your financial consultant>Margin loanAny purpose>Bank-issued securities-based line of creditMost lawful purposes other than securities purchases or margin repayment>
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Ideal uses>Home equity line of credit✔️ Debt consolidation>✔️ Home improvements✔️ Short- or long-term liquidity needsMargin loan✔️ Stock purchases>✔️ Short-term liquidity needs❌ Long-term liquidity needsBank-issued securities-based line of credit✔️ Bridge financing>
✔️ Short- or long-term liquidity needs
❌ Small initial borrowing need