Investment lines of credit explained in under 5 minutes
Definition of Investment Line of Credit and Examples
An investment line of credit, also known as “securities-based lending,” involves using securities as collateral for loans extended to investors.
Financial institutions set standards for acceptable collateral for lines of credit. Qualified securities can be stocks or bonds, but their values vary depending on how the financial institution assesses the submitted securities.
The borrower deposits approved securities into an account that is pledged to the lender. Generally, lenders agree to amounts ranging from 50% to 95% of the collateral’s value.
Note: Investment lines of credit differ from other portfolio-based lending options. They are lines of credit (similar to credit cards or home equity lines of credit) that remain open as long as payments are current and margin value is maintained.
The exact amount available to the borrower depends on the underlying asset’s value in the portfolio – the investor’s assessment may differ from the lender’s assessment. For example, if you inquire about a line of credit, the lender might agree to lend you $100,000 based on the value of the stocks you provided.
However, after reviewing your portfolio, the lender may decide that you can obtain a line of credit worth $190,000 if you provided $200,000 in U.S. Treasury bonds as collateral instead.
Alternative definition: A loan granted to an investor based on the value of the securities provided to the lender as collateral. Alternative names: Pledged Asset Line, Securities-Backed Line of Credit. Abbreviations: PAL, SBLOC, PLOC.
How Does an Investment Line of Credit Work?
Once an investor is approved for a line of credit and the collateral is deposited in the lender’s account, they can access the funds. Generally, they can write a check against the line of credit or transfer money to a bank account.
Note: As the value of the underlying collateral changes, the credit capacity in the account may also change. If the value of the investment instrument fluctuates due to market conditions, the lender may require the borrower to deposit additional collateral – possibly cash or other stocks and bonds, similar to maintaining a trading margin.
The borrower can also repay part or all of the outstanding loan balance. If payments do not start within a certain period known as the “cure period” – which can range from two days to 30 days – the lender has the option to liquidate (sell) the collateral provided by the investor.
Individuals and joint investors can create lines of credit for their portfolios. Living trusts that are revocable where the beneficiary and investor are the same person can also qualify. Loans can start at many financial institutions from $100,000 and go up to millions for high-net-worth accounts.
These loans have terms tailored to the borrower, with short to medium durations; five years is the common term.
Benefits and Risks of Investment Lines of Credit
Benefits:
- Provide borrowers with significantly lower interest rates.
- Greater flexibility in debt repayment.
- Provide a grace period to meet additional collateral demands.
- Reduce risk.
- Lower taxes to access your investments.
Risks:
- The value of the pledged assets may decline enough to incur significant debt.
- All collateral may be lost without notice.
- The lender may request additional collateral if the value of the held assets declines.
- Profits from stocks in the account may go to the account.
Note: The lender may become uncomfortable with specific securities designated as collateral, leading to additional collateral requests or the sale of the securities.
Investment Line of Credit vs. Home Equity Line of Credit (HELOC)
| Investment Line of Credit | Home Equity Line of Credit (HELOC) |
|---|---|
| Secured by your investment portfolio | Secured by your home |
| Loss can lead to loss of your investments | Loss can lead to loss of your home |
| Tax benefits possible if the loan is used to purchase taxable investments | Payments |
When an investment line of credit is granted, investments are used as collateral. With a mortgage-backed line of credit, your home is the collateral. This can be risky, as you could lose the value of your investments and the right to your home.
Tax benefits vary, as you can claim deductions for interest on a mortgage-backed line of credit if the funds are used for home improvements or repairs. In the case of the investment line of credit, you may be able to claim some deductions if it allows you to purchase taxable investments. Generally, this is not allowed in the investment line of credit, so the available tax benefit is limited to offsetting capital gains when you access your investment funds.
Key Takeaways
- Portfolio-backed lines of credit are loans that use investments as collateral.
- You lose control of your assets when they are placed in a portfolio-backed line of credit account as collateral.
- You must maintain the margin value, and the lender can sell your assets at any time if you default on payments or if the value declines.
- Portfolio-backed lines of credit and mortgage-backed lines of credit are similar but use different types of collateral. They are also subject to different taxes.
- You can access your investments using a portfolio-backed line of credit and avoid paying capital gains taxes.
The Balance does not provide tax, investment, or financial services advice. The information is provided without regard to the investment objectives, risk tolerance, or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks, including the risk of losing capital.
Source: https://www.thebalancemoney.com/securities-backed-lending-for-beginners-4077080
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