What’s the worst thing about unexpected expenses? Is it:
- They’re expensive?
- They come at the worst time?
- You can’t prepare for them?
- All of the above?
Although “All of the above” may seem like the safe bet, the truth is it’s a trick question. First of all, “worst” is subjective to everyone’s individual life situation. And second, there are steps you can take to prepare for unexpected expenses. A securities-backed line of credit (SBLOC) is one step to consider.
When an unexpected expense, such as a tax or medical bill or a major other purchase, comes along and you don’t have the needed cash on hand, what are your options? There are several you could consider. You could borrow money through a personal loan or sell stocks from your portfolio to raise cash. If the expense is a luxury, you could implement a savings plan and wait for a more advantageous time to make your purchase. But what if you had access to the value of your investments, without liquidating and losing their future growth potential? You can, with an SBLOC.
Key advantages of SBLOCs
An SBLOC allows individuals to borrow money backed by the assets in their investment portfolio without needing to liquidate the underlying securities. They function similarly to a home equity line of credit in that they can be drawn on and paid off multiple times. One key advantage of SBLOCs — aside from not being collateralized with your house — is that they are non-purpose loans. That means you can use them to pay that unexpected bill, buy a boat or send your child to college. The only thing you can’t do with an SBLOC is invest in more securities. For many, a preferred use of their SBLOC is not using it at all, but simply maintaining it as an available safety net.
A securities-backed line of credit:
- Allows investors to stay invested and continue earning interest on their portfolio
- Helps investors avoid untimely capital gains events due to the sale of securities
- Often has a lower interest rate than a personal loan
- Can be used for any expense or purchase other than investing in more securities
- Requires interest-only payments on the loan
Qualifying for an SBLOC is generally not a high-barrier process, but will likely involve a credit check and assessment of the fair market value of your investments. The amount of credit you qualify for will depend on the financial institution you are using and their requirements around the value of your assets as well as the type of securities in your account. Generally, you can expect to have access to anywhere between 50% and 95% of the value of your underlying investments.
What to consider before doing an SBLOC
As with any financial product, SBLOCs aren’t without considerations. They are variable interest rate products, which means the interest rate can change over time and make the cost of borrowing more expensive. It’s important to consider and consult a financial adviser as to whether the value of the assets in your underlying account will outpace the cost of borrowing against them.
But the primary risk associated with an SBLOC is the potential effect of a market downturn. Because SBLOCs are collateralized with the securities in your investment account, a market downturn could devalue your investments relative to your outstanding credit, prompting the lender to lower your credit line or issue a margin call. As part of a margin call, you would be required to either add collateral to your account, pay off the loan or risk the liquidation of the underlying securities in your account to satisfy the outstanding loan. What’s more, you would not be entitled to choose which securities the lender sells, and you could be liable for capital gains taxes based on the proceeds of the securities sold.
That may sound like a nightmare scenario, but you can mitigate that risk by building a resilient portfolio with a well-diversified set of investments that’s not too heavily focused on any one sector or investment type. It’s important to make thoughtful and informed decisions around both market risk and your ability to repay the line of credit.
Securities-backed lines of credit can provide a versatile funding stream or safety net while still taking advantage of the long-term growth of your investments. Your adviser can help decide if and how an SBLOC could work as part of your long-term financial plan.
