Why you should have a securities-based line of credit
Most Americans are familiar with the concepts of good debt and bad debt. They intuitively grasp that a mortgage can help them build wealth over time, while credit card debt will sap their wealth.
But even many sophisticated savers are unfamiliar with another type of enriching debt. The securities-based line of credit offers an ideal way to act as a lender to yourself.
My experience suggests that 95%of people who are eligible for this type of borrowing do not use it, often because they are completely unaware that it is available to them. This is shortsighted.
These lines of credit are set up against your taxable investment accounts. Individual Retirement Accounts and 401(k)s are not eligible.
Typically borrowers can borrow around half of their liquid investable assets. For example, if you have a $300,000 portfolio you can generally borrow up to around $150,000.
Some holdings are eligible for lower or higher loan amounts, so you check with your financial institution for your precise eligibility.
How much does it cost?
There generally is no cost to set them up a credit facility and no ongoing fee to maintain it. You are paying only interest expense on the amount you borrow, if you borrow at all.
Rates on these facilities are typically a bit above or a bit below Prime. In early 2021, Prime was at 3.25%. Pricing typically is based on the size of your relationship with the financial institution with lower-priced loans going to larger clients.
What are the benefits?
These facilities offer incredible flexibility with respect to the terms. Typically there is no amortization and you can pay down any amount at any time you want.
What is pretty amazing is that typically there also is no required monthly payment. You can let the interest “cap and roll”--which means that it just adds on to your principal balance.
This may or may not be a good long‐term strategy, but it offers tremendous flexibility for the borrower—in good times and in bad times. The term asset‐based loan facility refers to what is called margin and securities-based lending.
What’s the catch?
One of the greatest risks is that your ability to borrow is based of of the value of your portfolio. Therefore, if your assets go down in value, you can borrow less money.
This means that you have to always pay close attention to your coverage ratio, which is a way of looking at how much you have borrowed versus your ability to borrow.
To protect yourself, never borrow more than 50% of your available credit. This means that if you have a $300,000 portfolio, your financial institution will cap your lending to $150,000.
You should impose your own cap of 50% of that --$75,000 of borrowing, in this example.
Walk me through a scenario
Say you carry $25,000 of high-interest credit card debt, but you also have a $150,000 investment portfolio in a taxable account. You may be able to borrow money against the $150,000 at something like 3% interest and pay off your credit card debt.
The concept is simple, 3% is better than 20%.
In the $25,000 example, at a rate of 20%, you’d owe $5,000 a year in interest, or $416.67 a month.
At 3%, you’d owe just $750 a year in interest, or $62.50 a month.
It gets even better: Many portfolio lines of credit do not have required minimum monthly payments. If you choose, you can allow the interest to “cap and roll” until you are ready to pay off the interest and then the $25,000 itself.
Of course, you absolutely must keep an eye on how much money you borrow this way. But the reality is that, right off the bat, you’re saving more than $4,000 a year in interest.
This foundational better debt practice is relatively easy to implement, really works, and already has been taken advantage of by many high‐net‐worth people.
It’s time for all Americans to be aware of these strategies.
How may I help you?