What is securities-based lending?
Executive Director and Wealth Advisor, J.P. Morgan Wealth Management
- Securities-based lending (SBL) is the practice of a lender – typically a financial institution – loaning capital to an investor, backed by collateral in the form of one or more eligible marketable securities owned by the investor.
- SBL provides the opportunity for quick access to liquidity, often on a tax-deferred basis.
- Read on to learn the nuances, use cases and important considerations of securities-based lending to determine whether it may be beneficial to your financial goals.
How does securities-based lending work?
Securities-based lending (SBL) is the practice of a lender – typically a financial institution – loaning capital to an investor, backed by collateral in the form of one or more eligible marketable securities owned by the investor. This provides a means to extract liquidity from an investment portfolio without selling the underlying securities, which may offer a valuable way to meet short-term liquidity needs.
Key facts about SBL
- There are no costs to establish or fees to maintain a securities-based line of credit.
- The borrower is only required to pay interest on amounts drawn from the SBL line.
- The borrower may make principal payments on their own schedule, as opposed to other forms of credit, like installment and mortgage loans, which typically require regular principal and interest payments.
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Eligible investment accounts for collateral in SBL
Not all asset classes or types of securities can be used as collateral. For example, assets held in retirement accounts are not eligible. Examples of securities that may be deemed eligible for collateral include stocks, bonds, exchange-traded funds (ETFs), mutual funds and Treasuries.
When establishing an SBL, the lender will review your portfolio and determine the maximum amount you qualify for based on the securities held in your investment account(s).
Advantages of SBL
A securities-based loan provides the potential to access liquidity from an investment without selling assets. This is beneficial in that it allows you to stay invested for the long term while still having the option of quick, tax-free liquidity access if needed.
How? Well, securities-based loans provide immediate benefit from not-yet-fully-realized portfolio gains without first paying the tax on those gains (since you are not required to sell the portfolio assets), which is one potential consequence of simply selling a security to raise funds.
Because backing a loan with readily marketable collateral is highly liquid, the interest rate charged may be more favorable to the borrower than alternative financing options such as credit cards, unsecured loans or certain home equity lines of credit. To boot, some SBL facilities do not charge origination fees or closing costs, which can further help to reduce the cost of borrowing when strategic financing is needed.
Important factors to consider for SBL
As with all variable credit facilities, interest rate increases can directly increase your debt servicing costs. Typically, interest rates charged for these types of loan facilities are based on a nationally published short-term interest rate – such as the Standard Overnight Funding Rate (SOFR) – plus a spread.
Naturally, market volatility can cause the value of the securities pledged as collateral to fall. When this happens, you may experience a shortfall in coverage, which can trigger a margin call that requires you to provide additional collateral or for you to reduce your loan balance. If you are unable to meet the call, the lender may liquidate your securities. If this happens, you may face tax consequences.
SBL potential uses
The practice of SBL is tailored to offer borrowers an array of solutions for capital needs like paying taxes, financing a wedding or travel, funding a new business venture or purchasing real estate.
SBL as a strategy can provide a sophisticated complement to a well-established investment plan by allowing you to keep your money invested while providing a cost-effective and tax-efficient means to access short-term liquidity when unexpected needs or opportunities arise.
Securities-based loans typically cannot be used to buy or sell securities, or to repay a loan used to buy marketable securities.
Next steps: Is SBL right for you?
Bottom line – determine whether securities-based lending could support your financial goals and what a reasonable amount to borrow might be. Defining which loan size makes sense for you often includes determining what loan threshold meets your potential liquidity needs, while keeping in mind the likelihood of collateral calls by not overleveraging your portfolio’s borrowing capacity.
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Executive Director and Wealth Advisor, J.P. Morgan Wealth Management
