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Life happens fast. At some point, you might need quick cash for a down payment or to cover an unexpected expense, but may not be sure whether it warrants raiding your emergency savings.
You could sell some of your investments, but right now is likely not the time: In the current bear market, selling stocks might lock in a loss. (Even in a strong market, you may raise cash but you'll probably also acquire a capital gains tax bill.)
Luckily, there’s another option to consider: stocks as a collateral loan. Using your brokerage account for financing through a securities-based line of credit, or SBLOC, could provide you with access to cash so you can grab on to an investment opportunity or make ends meet when you’re stuck in a jam.
How using stocks as collateral works
SBLOCs, also referred to as securities-based lending or portfolio financing, use the investments in your taxable brokerage account as collateral to back a revolving line of credit. This means you can choose how much to borrow and pay back without having set payments over a defined period of time.
To qualify, brokerage firms offering this lending solution may require a certain account balance and will calculate the maximum credit available to you — the collateral value — based on the eligible securities (generally stocks and bonds) within your account.
With the volatility of the market, you won’t be given a dollar-for-dollar loan, says Tolen Teigen, certified financial planner and chief investment officer at FinDec, a financial consulting company headquartered in Stockton, California.
“Perhaps you can use 60% to 70% of the value of your securities portfolio as collateral,” he says.
And the amount of assets you have at the brokerage firm usually plays into the interest rate you’ll get. Often, the more assets you hold at the firm, the lower your interest rate will be, which is why SBLOCs often make the most sense for those with larger account balances, Teigen says.
Securities-based line of credit example
Let’s say you’re surprised with a sudden high tax bill and would rather not empty out your savings or sell stock to pay it. You also know that your annual work bonus is coming up in a few months’ time. You could use your stocks as collateral and obtain a loan to bridge the gap for now, paying the loan off once your bonus hits your checking account.
An SBLOC can use more than stocks
One common misconception about SBLOCs is that you can only use the stock in your brokerage portfolio as collateral. In fact, you can use many different types of securities as collateral for a loan — bonds, mutual funds, ETFs, or money market funds also count toward the total loan value you’d have access to.
Financial firms that offer SBLOCs will run risk analysis on your portfolio when you apply for a loan. Diversifying your assets is one of the key ways to reduce risk, and SBLOC lenders generally will offer higher loan maximums to well-diversified portfolios with a blend of different securities.
Why use a securities-based line of credit
Though there are some hoops to jump through, establishing a SBLOC has advantages beyond avoiding capital gains tax consequences or undesired losses.
“It allows the investor to continue with their investment strategy without having to liquidate any holdings,” says Daniel Milan, managing partner at Cornerstone Financial Services in Southfield, Michigan. This means you won’t disrupt your portfolio’s asset allocation and can stay invested for the longer term.
“Typically, the investor has quick access to cash when they need to pull money from the line of credit, which creates flexibility,” Milan says.
Once your line is in place, you can usually access funds as needed within a few days. Even if you don’t need it, you can take comfort in having a backup plan. Repayment is also flexible as long as the required collateral value is maintained.
You can’t, however, use your securities-based line of credit to buy other securities or repay margin loans.
What to keep in mind
There are risks associated with securities-based lines of credit. One of the biggest is that the ups and downs of the market will affect the collateral value of your account.
When the value of the securities in your account falls below a certain threshold, the broker will issue a maintenance call, which is like a margin call — an order to add more cash or securities to your account. If you're not able to add more cash, you risk having some of your securities sold to meet the call. And you may face an unpleasant surprise: Your brokerage firm has the right to liquidate positions — the stocks, bonds and other securities you're currently invested in — without notifying you or asking for your input.
Additionally, rates for SBLOCs are variable, not fixed. So in a rising interest rate environment like the one we're in right now, your originally low interest rate may start to climb.
For these reasons, using stocks and other investments for collateral should be approached judiciously. When taking on any form of debt, it’s important to note a golden rule: Don’t bite off more than you can chew. Teigen and Milan agree that backing your SBLOC with less-volatile securities (like blue-chip stocks or bonds), using your credit line sparingly and having a concrete repayment plan are ways to mitigate the risks and ensure your securities-based line of credit remains a useful tool.
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