How to Unlock Opportunities with Securities-Backed Lending
New, innovative methods of lending and borrowing money are shifting how business owners and other high-net-worth individuals can access capital to reach their financial and professional goals. One of these methods is securities-backed lending, which promises successful investors a way to quickly access money by leveraging their investment portfolio.
What Is Securities-Backed Lending?
Securities-backed lending, also called securities-based lending, is the practice of providing loans to investors and using their securities (e.g., stocks, bonds, mutual funds, exchange-traded funds) as collateral. The borrower will temporarily transfer ownership of securities held in an investment account to the lender in exchange for receiving a loan or line of credit based on a percentage of their investment’s value. The securities offered as collateral mitigate the lender’s risk because if the borrower defaults on the loan, the lender can sell the securities to recuperate any losses from the loaned money. These types of loans are available through private banks, brokerage and advisory firms, and other large financial institutions, especially those that provide specialized lending services to high-net-worth individuals.
Who Can Benefit from Securities-Backed Borrowing?
Securities-backed loans are most accessible to high-net-worth individuals who have accumulated significant wealth in their investment portfolios. This type of borrowing is often used when someone wants to make a large purchase on short notice, especially when most of their assets are illiquid (i.e., cannot be easily cashed out at a moment’s notice), such as money tied up in real estate or long-term investments. Securities-backed loans are flexible and not tied to a specific purpose, so they can meet a wide range of financial needs and be useful to wealthy individuals, entrepreneurs, and even companies. The borrower may use this money to purchase investment properties, fund the expansion of a small business, book a luxury vacation, pay college tuition, or make other large personal or business purchases, excluding the purchase of more securities.
What Are the Advantages of Securities-Backed Loans?
One of the biggest advantages of securities-backed loans is that the borrower can gain access to liquid assets without actually liquidating (i.e., selling) their securities, incurring capital gains taxes, and altering their asset allocation in unwanted ways. In most cases, the borrower can still trade and purchase securities in their portfolio as long as they stay above the required collateral value for the loan, and a well-performing portfolio may be able to earn more than the borrower will pay in interest. Securities-backed lending enables investors to maintain their long-term investment strategy while benefiting in the short term from their accumulated wealth.
Another advantage of securities-backed lending is the quick reception of loan amounts (i.e., often within a couple of days). This easy access to liquidity allows investors to feel more secure in investing more of their money instead of keeping a large savings account with an interest rate that does not outpace inflation. In the case of an emergency or unexpected opportunity, high-net-worth individuals can leverage their investments to quickly access cash without needing to sell assets. This aspect makes securities-backed loans popular among real estate investors, who want the flexibility of being able to buy properties when an opportunity arises without having to keep hundreds of thousands of dollars in cash on hand at all times.
Finally, securities-backed loans often have more flexible terms and repayment options and lower interest rates than unsecured lines of credit, such as credit cards or personal loans. Because the lender keeps your investment portfolio as collateral to protect themselves from loss if you default on the loan, they can offer better terms at a lower risk to themselves. The terms, interest rate, and repayment options will vary for each loan, so it’s wise to shop around and compare your options.
What Are the Risks of Securities-Backed Loans?
One risk of securities-backed borrowing is that the leveraged portfolio’s value may drop with a decline in the market. In that case, the borrower may need to add more funds to the investment account to maintain its overall value. This situation is referred to as a “margin call.” The value of securities is often changing and unpredictable, so borrowers risk a temporary decrease in value at an inopportune time. If the borrower doesn’t add more funds or somehow increase the value of their portfolio to meet the lender’s requirements, the lender can sell some or all of their securities.
A related risk is that borrowers cannot control which assets are sold if the lender chooses to liquidate only a portion of the portfolio. This means the lender might throw off your overall strategy by selling an asset you would have preferred to keep. Even if you recover its lost value after repaying the loan, you will have missed out on its growth while it wasn’t in your portfolio [AG1] and will likely have to spend time rebalancing the account to achieve your preferred asset allocation.
If you cannot pay off your securities-based loan for any reason, you may lose your entire portfolio. If this happens, you will likely have to pay taxes on the securities’ value when they are sold, and you will lose your progress in growing that portfolio and accumulating wealth.
Before pursuing securities-backed borrowing, it’s essential to thoroughly research and understand the terms of the loans you are interested in and the risks involved. Securities-based loans can be a powerful tool for growing your net worth and capitalizing on time-bound opportunities, but if taken out carelessly, they can set you back and eliminate years of progress toward reaching your financial goals.
If you are looking into securities-backed lending to facilitate the next step in your or your business’s financial journey, you would likely benefit from working with a top-notch financial advisor. Business & Financial Strategies has a team of financial professionals prepared and excited to have an initial 20- to 30-minute in-person or virtual initial conversation with you about your financial goals and needs. Its financial advisors provide personalized guidance tailored to help you make prudent and strategic moves that align with your financial objectives, time horizon, and risk tolerance. Business & Financial Strategies has offices in the Iowa City/Coralville area and Fairfield, Iowa, and they it serves clients from all around the United States. To learn more, call 319-358-7700 or go to visit www.BFSFinanicalPlanning.com to schedule a complimentary initial conversation.