How Securities Based Loans Work

A securities based loan, or margin loan, is line of credit secured by assets in your investment portfolio. These loans typically come with a relatively low interest rate, and can be processed and issued fairly quickly.

However, by using your portfolio as collateral, these loans also depend on the value of your underlying assets. And if the market dips too far, your lender can call in the loan or force a sale on your investments. This makes SBLs riskier than other types of loans, though they can be successfully used to solve short-term liquidity needs.

Talk to a financial advisor to discuss the pros and cons of a securities based loan in your situation.

What Are Securities Based Loans?

A securities based loan, or SBL, is a form of secured lending that uses your investments as collateral. Lenders allow you to use most mainstream assets for a securities-based loan, including stocks, bonds, and shares in a mutual fund or ETF.

Typically, lenders structure a securities based loan as a line of credit. This means that instead of extending the loan in one, lump-sum transaction, like a personal loan or a mortgage, the lender allows you to borrow at any time and in any amount up to a limit of your portfolio value. As you repay past borrowing, this frees up room for new borrowing under the cap.

This type of loan can be extended by any lending institution, and will typically be handled by banks or brokerages.

The idea behind a securities based loan is to help you access your portfolio’s value without having to sell its underlying assets. For example, say that you have $10,000 in stocks. You would like to use some of that money, but you also believe those shares will continue to gain value. A securities based loan gets you cash based on those stocks without having to sell them.

However, many securities based loans have terms which necessitate an immediate payback of some of the loan if your portfolio value drops below a certain value.

How Do Securities Based Loans Work?

When you take an SBL, you will nominate the assets that you want to use as collateral for this loan. For example, you might stake a $5,000 bond portfolio or $10,000 in stock shares. Your lender will then offer a loan based on the nature of the underlying assets and the amount in the portfolio. In some cases a lender will also check your personal credit score, although this is less common.

Securities based loans typically range between 50% and 90% of the value of the underlying portfolio, sometimes referred to as your initial margin maintenance. Lenders don’t issue dollar-for-dollar loans in case the underlying asset loses value, and they typically give larger loans for less volatile assets.

So, for example, you might receive up to 90% of the value of a Treasury bond while you might get just 50% of the value of a stock portfolio. This is because the stocks are far more volatile than the bonds. Lenders have no upside in case the stocks gain value, they cannot collect more than the value of the loan, so for them that volatility is pure risk. They want to protect themselves against the possibility that the portfolio will lose significant value, leaving them without enough collateral to secure the loan.

Talk to a financial advisor about an investment plan that meets your risk tolerance.

How to Pay Back a Securities Based Loan

Most securities based loans do not require minimum payments on the loan’s principal. You only have to make regular payments on the interest, which is based on the same terms as the loan itself. Like with a credit card, you only owe interest on the money you have actually borrowed, not the total borrowing authority.

Interest is one of the main advantages to a securities based loan. Since these are secured loans, they tend to offer very low interest rates compared with other personal lending. However it’s also common for these loans to have variable interest, meaning that your rates can change from month to month based on the market.

Risks of Securities Based Lending

The biggest risk arises if you default on a securities based loan your lender may seize the underlying assets. If this happens, the lender may sell off the assets and use that sale to repay the balance of the loan. You will receive any excess, but you will owe any remaining balance. You will also owe any applicable capital gains or income taxes on the sale.

However, your lender can also track the value of your collateral. If the value of your underlying securities drops too far relative to the value of the loan, your lender may issue what’s known as a “margin call.” During a margin call your lender can require you to either stake additional assets, to increase the value of your collateral, or to repay the loan.

If you can’t or don’t meet these terms, your lender can sell unilaterally sell assets to cover the value of your loan. You will have no control over which investments they sell or when. If your collateral is not enough to repay the loan, as above, you will be required to make up the difference. Also as above, you will be responsible for any applicable taxes on this sale.

A margin call is the big danger to securities based loans. Ordinarily, short term volatility in the market isn’t a big problem for most investors. You can hold your assets and wait until prices recover. However if you hold a securities based loan, particularly if you owe a lot of money on it, that volatility can trigger a margin call, forcing you to repay the loan, sell your assets or both. Since market fluctuations are beyond your control, and since bear markets often correlate with larger economic recessions, this is a significant risk.

Depending on how you use it, a securities based loan can help you access cash from your portfolio while holding your position. But this can be a very dangerous form of lending, especially if you use stocks or other volatile assets as your collateral.

To determine the best plan for you, talk to a financial advisor today.

Bottom Line

A securities based loan is a line of credit that you take out using your investments as collateral. Under the right circumstances they can be a good way to access cash from your portfolio, but be careful. With volatility, you can lose your loan and your investments.

Personal Lending Tips

A personal loan can be a great way to access cash, especially if you use it for something that adds value like home updates or educational expenses. But before you borrow a penny, make sure you know exactly what that money will cost you.
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