securities based line of credit

The Complete Guide to a Securities Based Line of Credit

A securities-based line of credit is invaluable for building, maintaining, and managing wealth. It can provide immediate liquidity for emergencies, funds for a downpayment, business startup or purchase, tax payments, etc. However, the average investor remains in the dark regarding when, how, and why to employ a securities-based line of credit. This is your complete guide to a securities-based line of credit!


What is a Securities Based Line of Credit?


A securities-based line of credit is a secured loan backed by investments in a taxable brokerage account. For example, let’s assume an investor has a $1,000,000 taxable brokerage account. Depending upon the type of investments within the brokerage account, the line of credit will be anywhere from 50-70% of the overall account value, depending on the risk analysis completed by the lender. In this case, the investor could borrow up to $500,000-$700,000 from their securities-based line of credit without selling their investments. Providing a line of credit for future liquidity purposes.

The lender charges an interest rate only when the securities-based line of credit has a balance. They typically are free for the investor to set up through their custodian. The interest rate comprises a fixed rate (typically established when the line is opened) and a variable rate. The variable rate is often tied to the 30-day SOFR (secured overnight financing rate), a broad measure of the cost of borrowing cash overnight collateralized by treasury securities. Together, these two interest rates make up the interest rate the borrower would owe on any balance on the line of credit. Payments are interest only, and the balance can be paid off at any time or held for however long the investor wishes to.

Using the prior example, assume the investor borrows $100,000 from their line of credit. The hypothetical interest rate is 5% APR. Every month, the investor/borrower would pay $416.67 for $5,000 annually. Generally speaking, security-based lines of credit offer superior interest rates to other secured lines of credit, such as a home equity line of credit (HELOC).

Tip: We use Charles Schwab for our clients as their custodian, and we can facilitate the process of opening a securities-based line of credit for our clients, along with any future loans or repayments. 


Potential Use Cases for Securities-Based Line of Credit


By setting up a securities-based line of credit, an investor establishes additional, near-immediate liquidity without worrying about the day-to-day market fluctuations of their investments or potential tax consequences of selling appreciated assets. In most cases, the line of credit should be viewed as a short-term liquidity tool, not something that should be relied upon for everyday spending or as a long-term loan. If used for daily spending or as a long-term loan, poor financial habits are likely being established or already in place. It can also set up the borrower for a potential call to pay off the loan by the lender, should the invested securities fall in value enough to warrant so.

Therefore, the securities-based line of credit is best used for short-term liquidity and in cases where the borrower has planned ahead of time how they’ll eventually pay off the line of credit.


New Home Purchase


There are many situations where a securities-based line of credit can be useful when purchasing a new home. Let’s imagine you’re looking to upsize due to your growing family. Still, you have two children under the age of 5, and the thought of trying to move out of your current home, into a temporary residence, and then into a new home is stalling the process. Security-based line of credit to the rescue! Depending on the size of your line of credit, you may be able to buy the new home outright, in which case, you do not have to deal with a traditional mortgage lender whatsoever until you cash-out refinance the home to establish a fixed interest rate for the life of the mortgage on the new house. However, if you cannot purchase the new home outright, you can still use the line of credit for downpayment, moving expenses, closing costs, etc. When you’re settled in the new home, and your old house sells, you can turn around and use the home sale proceeds to wipe out the line of credit.

The strategy can be used for many reasons, including avoiding capital gains taxes through selling investments for liquidity, providing a “bridge” loan between the sale of the previous home and the purchase of the new house, lower interest rates compared to alternatives such as a HELOC, and ease of use compared to traditional mortgage lending.

Tax Payments


If you’re like many of our clients, who receive part of their compensation through equity, whether in stock options or restricted stock units, you may have encountered a situation where a large tax bill was due to come tax time. Ideally, through careful tax planning, these surprises are a thing of the past if you’re working with a financial planner; however, we’ve seen our fair share of new clients come to us with lingering tax payments from years past due to unforeseen tax consequences of equity compensation.

The securities-based line of credit can also bridge the gap between a large tax bill and the next equity vest. For all the same reasons stated above, it may not make sense to sell investments due to capital gains to pay a tax bill. Instead, using the securities-based line of credit to make the payment and then paying off the balance once the next equity vest occurs.

This same strategy can also be used for other financial goals, not just home purchases or taxes, but auto purchases, home improvement projects, etc. However, it’s also best practice to have a strategy on how the line of credit will ultimately be paid off rather than something that’s being used to accumulate more debt without any intention of paying it off.


Potential Disadvantages of Securities-Based Line of Credit


As with any financial product, there are potential downsides to utilizing a securities-based line of credit. Many risks can be avoided through strong financial habits, such as avoiding too much debt, planning to pay off the debt, and understanding interest rates. However, a few risks, such as market fluctuation, can cause forced liquidations of investments to cover the debt and aren’t always avoidable. Ensuring you know the potential disadvantages of a securities-based line of credit is crucial before utilizing it.

Variable Interest Rate


Since part of the interest rate applied to a securities-based line of credit is variable, the total interest rate is variable. In periods of rising interest rates, the payments on the balance of the loan will increase. The increase can cause a potential cash flow crunch or require the borrower to borrow more from the line of credit to cover the increasing loan costs in situations where rates have increased dramatically. Whence we believe the securities-based line of credit is best suited, in the vast majority of cases, as a short-term lending tool.


Can Lead to Bad Financial Habits


Securiites-based lines of credit are much more extensive than traditional quick liquidity credit tools such as credit cards or personal loans. With such an extensive line of credit at the borrower’s disposal, it could lead to poor spending choices. If you’re spending more on things you usually would not have the line of credit not exist, you may want to reconsider its use. Always plan how to pay off the loan balance so it doesn’t become a runaway train.

Market Volatility Can Lead to Forced Liquidations

Custodians that offer securities-based lines of credit run risk analyses on the underlying investments to determine how much they’ll lend relative to that particular investment. The weighted average of the money they’ll lend for each asset determines the total line of credit. Generally, this can be anywhere from 50% (for risky investments) to 70% (for less risky investments). This built-into buffer helps protect the lender from market fluctuations for the underlying investments so that there’s not a situation where the borrower has maxed out their line of credit for more than the underlying assets are worth.

However, in extremely high market volatility periods, the lender may force a liquidation to avoid the above example. A forced liquidation can have obvious negative impacts on the investor/borrower. They’re forced to sell investments at an inopportune time and potentially forced to pay capital gains taxes.


The Bottom Line


Securities-based lines of credit are a great wealth management tool. They can be employed for various purposes, though most often as a “bridge” loan, an immediate liquidity source, and an emergency fund extension. Generally, the risks of utilizing a securities-based line of credit can be mitigated through deliberate planning and adhering to good financial habits.

If you want to learn more about a securities-based line of credit, schedule a free consultation today!

Levi Sanchez, CFP®, CPWA®, CEPA®, BFA™
Levi Sanchez, CFP®, CPWA®, CEPA®, BFA™
Levi Sanchez is a CERTIFIED FINANCIAL PLANNER™, CERTIFIED PRIVATE WEALTH ADVISOR®, CERTIFIED EXIT PLANNING ADVISOR®, BEHAVIORAL FINANCIAL ADVISOR™ designee and Founder of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. Levi’s been quoted in the New York Times, Business Insider, Forbes, and is a frequent contributor to Investopedia. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!

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