What Is Securities-Based Lending?

Securities-based lending (SBL) or securities-based lines of credit provide access to capital using investments as collateral. Investors can use securities in their investment portfolios as loan collateral. SBL allows quick access to liquidity without liquidating investment accounts.

Although financial advisors and financial services firms sometimes market securities-based lending as a cost-effective lending solution when an investor needs a personal loan, it comes with several potential risks. This article discusses securities-based lending. It discusses SBL basics and what to consider before using the investment products in your brokerage accounts as collateral.

See FindLaw's Securities Law Basics section for more articles and resources, including Securities Law: An Overview and Basic Terms for Shareholders and Investors.

Overview of Securities-Based Lending

Securities-based lending is straightforward. Brokerage firms, wealth management companies, or broker-dealers loan money to existing investors. Securities-based lending generally works like a home equity line of credit.

With a home equity line of credit, a house serves as collateral in the case of a default. With securities-based lending, securities serve as collateral in case of default. In both cases, investors can draw funds from the line of credit, pay it down, and draw funds again.

Collateral for the Loan

The financial services industry has long used collateral to secure a loan. But using stock and bonds as collateral is a relatively new investment strategy.

Securities such as fully paid-for stocks, bonds, and mutual funds are collateral for a securities-based loan. When the markets produce positive returns, these types of loans can be a critical source of revenue for financial institutions and investment advisors.

A Revolving Line of Credit

A securities-based line of credit is a revolving line of credit using securities held in investment accounts as collateral. The loan can require borrowers to make interest-only payments. It remains outstanding until repayment. The borrower can repay the principal at any time.

Advantages of Securities-Based Lending

Securities-based lending has proven attractive to financial firms. Banks and brokers generally get fees for managing their clients' investments and assets. Offering loans tied to their existing business increases revenue.

A financial institution or broker already holds the collateral; the existing customer is a known quantity. In recent years, financial firms have made a big push to increase securities-based lending. Many firms reward employees who make them with lucrative bonuses.

These loans can benefit borrowers just as much as lenders. Most people hold stocks, bonds, and other securities. People have retirement accounts or taxable brokerage accounts. They accumulate wealth for retirement, kids' college tuition, real estate purchases, and other purposes.

Securities-based lending allows investors to raise cash quickly while benefiting from a secured loan's favorable terms and keeping the underlying stocks and bonds in a portfolio. The mixture of collateral, an existing relationship with the bank or broker, and favorable loan terms offer real value. The main question is whether these loans are suitable for you.

Securities-backed loans offer distinct advantages, including the following.

Cost

The interest rates for a securities-based loan are typically lower than the rate for a personal loan or line of credit from your bank or by using a credit card. This is a significant advantage.

Also, some lenders may not require a credit check on credit approval for the SBL. The maximum credit may be based on the value of the collateral portfolio alone. Investors can borrow up to 50% to 95% of the asset's value, depending on the collateral type.

With SBLs, firms can offer lower interest rates and make larger loans. This makes securities-based lending an attractive source of cash.

The financial institution or broker-dealer determines the limit an investor can borrow against their portfolio. It's called the advance rate. People can't borrow against the total value of their portfolios. Typically, the more diversification in a portfolio, the higher percentage an institution may be willing to lend.

Flexibility

An investor can use a securities-based loan for a variety of purposes. They are non-purpose loans. Common uses include the following:

• Consolidation of debt with higher interest rates
• Real estate transactions
• Education expenses
• Business financing, including startup financing
• Luxury purchases such as fine art, boats, expensive jewelry
• Tax payments
• Personal expenses

Borrowers can use a non-purpose securities-based loan for nearly any purpose. But an SBL can't be used to buy securities.

Tax Efficiency

Securities-based lending allows investors to use their investments' value to get cash. Securities-based loans allow you to keep control of your investments and avoid potential capital gains taxes and high interest rates associated with credit cards. At the same time, you keep your holdings and continue reaping benefits such as dividends and appreciation. With SBLs, you don't have to sell stocks, bonds, or other investments. Selling securities could trigger capital gains taxes or other adverse tax consequences.

Disadvantages of Securities-Based Loans

Securities-based loans come with risks. We'll discuss some of the most common disadvantages below.

Market Volatility

The loan's collateral, pledged securities, has a value affected by events outside your control. The loan is tied to securities and is subject to market fluctuations. The lender may call in the loan early or demand increased collateral.

With market volatility, the market value of the securities can decline. If the collateral value falls below the required levels, it may trigger a margin call, sometimes called a maintenance call. It happens when the SBL lender requires extra collateral. If the value drops enough, firms can call in the loan or demand increased collateral from the borrower. This can leave borrowers in a pinch, needing to raise cash or sell stocks. The borrower must deposit more funds or repay the loan.

Interest Rates

Securities-based loans share the same disadvantage as all other loans — the amount received must get paid back with interest. This can cost more in the long run than relying on wages, savings, or investment income. Those options are also less risky. Plus, there's always the risk of the borrower becoming insolvent and not repaying the loan amount.

You Can't Use the Loan to Buy Securities

As discussed above, there's a key limitation to securities-based loans. You can't use the cash to buy more securities or trade securities. This distinguishes SBL from margin loans. You can buy securities with a margin loan but not a securities-based loan.

Need More Help Understanding Securities-Based Lending?

Securities-based lending can be attractive as a quick, affordable, tax-friendly option for borrowing money. But whether this holds true depends on the situation. It's important to understand the loan's terms and the risks involved. Before you agree to borrow money secured by your investment portfolio, consider speaking with a securities law attorney. They can explain the legal ramifications given the particular loan under consideration.