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 that’s backed by collateral in the form of one or more eligible marketable securities the investor owns.
- SBL provides the opportunity for quick, often tax-deferred liquidity access.
- 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.
What is securities-based lending?
Securities-based lending (SBL) is the practice of a lender, typically a financial institution, loaning capital to an investor that’s backed by collateral in the form of one or more eligible marketable securities the investor owns. This provides a means to extract liquidity from an investment portfolio without selling the underlying securities, which may offer a valuable source of meeting short-term liquidity needs.
How does it work? A few key facts
- There is no cost to establish or fees to maintain a securities-based line of credit.
- The borrower is only required to pay interest on the amounts drawn on 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 that typically require regular principal and interest payments.
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Which types of investment accounts can be used as collateral for SBLs?
Not just any asset class or type of security can be used as collateral. For example, any asset held in a retirement account is 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 you’re working with 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 (because it does not require you 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 is typically more favorable to the lender than alternative financing options such as credit cards, unsecured loans or home equity lines of credit. To boot, as mentioned above, most 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
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 to the loan 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 reduce your loan balance. If you are unable to meet the call, the lender may liquidate securities. If this happens, you may face tax consequences.
Potential uses
The practice of SBL is tailored to offer borrowers an array of solutions to other capital needs like paying taxes, financing a wedding or travel, funding a new business venture or purchasing real estate. Securities-based loans are often established with investors as a backup source of liquidity simply to provide alternatives to cover unexpected expenses, such as a car or house repair.
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 are typically not able to be used to buy or sell securities or repay a loan used to buy marketable securities.
Next steps
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. Bottom line – a financial advisor can help you determine if securities-based lending could support your financial goals and help you decide on a reasonable amount to borrow.
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Executive Director and Wealth Advisor, J.P. Morgan Wealth Management
