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If you're an investor, you may be able to use some of your stocks, bonds, exchange-traded funds and other securities to secure a loan. Securities-based borrowing is unlikely to affect your credit, and may even be a good option for borrowers with low credit scores who can't qualify for traditional loan options.
This type 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 allows you to use your investment portfolio as collateral to secure loan funds. Historically, this type of loan has only been available to high net worth investors, but it has recently become an option for investors with modest portfolios.
Depending on the lender, you may be able to get an installment loan or a revolving line of credit. Loan and credit line amounts can range from 50% to 95% of the assets used as collateral, depending on the institution and the size of your portfolio.
Once you're approved for a securities-based loan, the financial institution will place the collateral you've chosen to use in a separate, locked account. That means you won't be able to make any trades until you've paid the loan in full.
If you stop making payments on your loan, the lender can seize your collateral and sell it to recoup your unpaid balance. Also, if the value of your collateral drops significantly enough, you may be subject to a margin call, which means that you'll need to deposit more money into your investment account. If you can't, the lender may sell some of your portfolio to cover it.
Pros and Cons of Using Securities-Based Lending to Borrow Money
There are some solid reasons to consider leveraging your investment portfolio to get a loan, but the risks may be too high for some.
- Interest rates are relatively low. The collateralized nature of the account allows lenders to charge interest rates in the single digits, which can be much 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 if you don't want to lose potential future growth in those positions, this type of loan makes it so you can hold on to them.
- It's an option for borrowers with bad credit. Getting most kinds of loans with bad credit can be challenging. But with securities-based lending, credit standards are far less stringent.
- Interest is typically variable. These loans typically carry a variable interest rate, which can fluctuate over time with market rates. If interest rates start increasing, so can the cost of your loan.
- You could be subject to a margin call. If the value of your portfolio drops below a certain amount, the lender may liquidate some or all of your collateral to satisfy the margin call. The only way to avoid this is to deposit more cash into your investment account. Considering you just borrowed money, however, you may not have that kind of cash on hand.
- Your access to your portfolio will be restricted. You won't be able to make any trades on your collateral while your loan is outstanding without permission from the lender. If prices start dropping, there's nothing you can do about it.
- You may lose your portfolio. If you can't pay back the loan for any reason, the lender may seize your collateral and liquidate it to recover the remaining principal balance.
- There may be tax implications. If the lender liquidates any of your assets due to a margin call or default, you'll be subject to taxes based on IRS rules. If you've held the assets for less than a year, your gains will be taxed at the ordinary income rate. If you've held them for longer than a year, they'll be subject to the lower long-term capital gains tax rate.
- They won't help you build credit. Unlike personal loans and other forms of debt, on-time payments usually aren't reported to the credit bureaus and therefore 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 based on 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 using one to build your credit history, you may want to reconsider.
Alternatives to Securities-Based Lending
A securities-based loan can be tempting, especially if your credit is less than perfect. But if you need funding now, consider other options before you decide to risk your investment portfolio.
- Sell off some of your portfolio. While it might not be ideal, selling off some of your investments may be simpler than using them to secure a loan. Remember to consider the tax implications of this option.
- Use your credit cards. If you already have credit cards, consider using them to cover your expenses if possible. The interest rate will be higher, but it leaves your portfolio intact.
- Apply for a personal loan or credit card. If your credit is in decent shape, you may be able to get a relatively low interest rate on a personal loan or even a credit card with 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 a personal loan or credit card with a favorable interest rate on your own, consider asking loved ones for a loan that you'll pay back.
- Improve your credit. If you don't necessarily need the money right now, consider taking time to improve your credit before you apply for a traditional loan option. Check your credit score and credit report to get an idea of where you stand and where you can make some adjustments, then take action to address negative credit items.
Take your time to consider all of your options before settling on a securities-based loan. Building credit can take time, but the long-term benefits of lower interest rates on traditional loans are worth the effort.