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It happens. You might find yourself in need of quick cash to pay a downpayment or cover an unexpected expense. However, it is possible that you are not sure if this is a good time to raid your emergency savings. It is possible to sell your investments but it depends on the market. You will raise cash if the markets are up. However, you might also be able to get capital gains tax bills. Selling might result in you taking a loss if the market is down.
There is another option: you can use your brokerage account to finance. A securities-based credit (or SBLOC) could give you cash access so that you can make an investment or get out of a tight spot.
Here's an example: Imagine you are shocked by a large tax bill. You don't want to sell stocks or drain your savings just yet. Your annual bonus as a worker is due in a few months. To bridge the gap, you could use your SBLOC and pay the loan off when your bonus hits your checking.
How securities-based lending works
SBLOCs are also known as portfolio financing or securities-based lending. They use your taxable brokerage account to secure a revolving credit line. You can choose how much you want to borrow and when you want to pay it back, without having to set repayments over a time period.
Brokerage firms that offer this lending solution might require you to have a certain amount of account balance. They will then calculate the collateral value and credit limit based on the securities (usually stocks or bonds) in your account.
Tolen Teigen, chief investment officer and certified financial planner at FinDec, a financial consultancy company based out of Stockton in California, stated that due to the market volatility, you will not be granted a dollar-for–dollar loan.
He suggests that you could use as collateral 60%- 70% of your securities portfolio.
The interest rate you get will depend on how much assets you have at your brokerage firm. Teigen states that the interest rate you get will often be lower if there are more assets at the brokerage firm. This is why SBLOCs can make sense for people with higher account balances.
Why choose a line of credit that is securities-based?
Although there are hurdles to overcome, the benefits of establishing a SBLOC go beyond avoiding capital gains tax consequences and undesired loss.
This allows investors to keep their investments going without needing to liquidate any assets, according to Daniel Milan, managing partner of Cornerstone Financial Services, Southfield, Michigan. You won't have to disrupt your portfolio's asset allocation, and you can continue investing for the long term.
Milan states that investors are able to access cash quickly when they have to draw money from the line. This creates flexibility.
You can usually get funds within days of establishing your line. Even if it is not necessary, you can still take comfort knowing that you have a backup plan. As long as you keep the collateral value, repayment is flexible.
SBLOCs are quick and can be cost-effective, due to current low interest rates. Stuart Blair, director, research, Canterbury Consulting, Newport Beach, California.
However, you can't use your securities-based credit line to purchase other securities or repay margin loan debts.
Keep these things in mind
Securities-based credit comes with risks. One of the most significant is the possibility that the market fluctuations could affect your account's collateral value.
The broker will issue a maintenance order or add cash to your account if the account's securities value falls below a threshold. You may have some securities removed if you are unable to add cash. You may also be surprised to learn that your brokerage firm can liquidate your securities positions without informing you or asking your permission.
SBLOC rates are also variable and not fixed. Therefore, even though interest rates are currently low, they may change over time.
It is crucial to use your securities-based credit responsibly.
Blair says that investors will need to decide how much leverage they are comfortable with, and then create a variety of worst-case scenarios to test their resolve.
It is important to remember a golden rule when taking on any type of debt: Don't eat more than you can chew. Milan and Teigen agree that backing your SBLOC using less volatile securities (like blue-chip bonds or stocks), using your credit card sparingly, and creating a repayment plan are all ways to reduce the risk and keep your securities-based credit useful.
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Tiffany Lam-Balfour writes about NerdWallet. Email: tlambalfour@nerdwallet.com.
