Sometimes, clients need cash and in some instances, they don’t want to sell securities to get that capital or pursue traditional borrowing avenues.
With that in mind, some may approach advisors for ideas about how they can quickly get their hands on significant amounts of cash through non-traditional means. Those clients deserve some credit for opting not to sell investments to cover an expense creates tax liabilities and means the client has a smaller portfolio and the advisor has fewer assets to manage.
In many instances, the answer to the query is a home equity line of credit (HELOC) for clients that are homeowners. HELOCs create long-term liabilities and thanks to rising interest rates, interest payments are higher on these products today than they were in 2020. For example, borrowers with excellent credit might be able to find a personal loan with an interest rate of slightly below 5%, but the reality is they’ll likely pay somewhere in the neighborhood of 7% to 8% on a $10,000-plus loan.
HELOCs aren’t for everyone. Not all clients need that much capital and plenty more don’t want such large long-term obligations. With that in mind, advisors should be knowledgeable in some of the other practical asset-backed lending options.
Margin and SBLs
Two primary ideas for clients with near-term liquidity needs are margin loans and securities-backed lending (SBL). The former is plausible for some clients, but come with some constraints.
“Margin loans typically require a minimum of $2,000 in cash or marginable securities and generally are limited to 50% of the investments' value. Interest rates vary depending on the amount being borrowed but tend to be lower than unsecured lending options such as credit cards,” according to Charles Schwab.
A securities-backed loan is a line of credit derived from the client’s portfolio. In a hypothetical example, Jane has $250,000 in non-retirement assets and she wants to access $25,000 for home improvements. SBL might be appropriate for her and perhaps a better idea than a HELOC or personal loan, particularly if she has a long-term investing horizon and isn’t imminently approaching retirement.
With SBLs, advisors should tell clients that the funds cannot be used to purchase securities or payoff margin loans. There are other requirements to consider.
“Such lines of credit also tend to require more borrowing than a margin account. For example, a securities-based line of credit for $100,000 may require you to take an initial minimum advance of $70,000 upon establishing the line,” adds Schwab.
Deciding Between Margin and SBL
In theory, advisors shouldn’t endorse margin loans for 99%-plus of clients because the reality is that percentage likely are not frequent enough nor successful enough traders to merit those loans.
That is to say among asset-backed borrowing options, SBLs are probably more practical to a broader swath of clients. However, SBLs aren’t perfect and clients considering that borrowing avenue should be well-versed in the risks, not just the rewards.
“Should the market value of the pledged collateral decrease, the bank may demand immediate repayment of outstanding obligations or require you to deposit additional cash or securities to the pledged brokerage account in order to avoid the sale of pledged assets,” adds Schwab. “Pledging diversified assets can help reduce this risk. Be that as it may, you should keep an eye on the value of your pledged assets—and have a backup source of funds in the event of a demand.”
Related: How Bitcoin Halving Might or Might Not Affect ETF Holders