Loans Against Investment AccountsBeau Ruff
Though most Americans have at least a passing understanding of the ability to use the equity in a house to obtain a low-interest loan though a Home Equity Line of Credit (HELOC), a lesser-known option for obtaining a quick line of credit financing might offer more compelling benefits for some. The financing option is available to individuals or businesses that maintain a non-retirement investment account and may provide lower rates than comparable HELOCs with the potential for faster processing times.
The key to getting a good interest rate on a loan comes down to the certainty that the lender will get repaid. To provide certainty, the lender often requires collateral to secure payment. On a HELOC, the collateral is the house and the equity the borrower has in the house. But using a house as collateral has some drawbacks for lenders. Customarily, an appraisal is required to validate the value of the house for the lender which can cost hundreds of dollars and takes weeks to perform. Additionally, in order to evidence the existence of the collateral obligation, the lender often has to record documentation with the local county auditor’s office which likewise takes some time and costs money. Lastly, if the lender ultimately needs to seize the asset for lack of payment, the process can be time consuming and costly for the lender.
Some Americans have another asset that is ripe for use as collateral for a line of credit: a non-retirement investment account. Because of the nature of this kind of asset, it can be a much swifter application process. Unlike a HELOC, no appraisal is necessary because the assets in an investment account are valued daily by the world markets. Unlike the HELOC, the lender need not record the security interest with any local county auditor’s office. And, for good or bad, if the lender needs to seize the asset for lack of payment, the process is likewise swifter and less costly for the lender. These advantages to the lender translate in many cases to cost savings for the consumer and the potential for a faster processing time.
Like HELOCs, different companies offer line of credit lending secured by the value of a non-retirement investment account. Typically (and like most HELOCs), the interest rates are variable and may change from month to month. Repayment options are also flexible. The borrower can choose to pay only the interest on the loan or can pay down the principal as desired. When a person takes the loan, the lender is granted access to the investment account so that it can be used as collateral to secure payment on the loan. While the collateral (investment account) is secured similarly to how a HELOC is secured by a home, the process doesn’t require filings with the county auditor’s office. Typically, a lender offers to loan in the range of about 65% of the value of the investment account.
For those individuals that maintain investment accounts and have the account set up for a line of credit, the access to financing is quick and easy. Typically, online access allows the borrower to request funds and have those funds deposited in a linked bank account within a day or two. For some, it might also provide a comfortable source of liquidity in a pinch. Accordingly, it could also allow an individual to feel secure keeping a lower amount of liquidity in savings accounts.
A notable downside of a line of credit based on an investment account is the inherent volatility of the asset. That is, though the investment account is easier to value because of the instantaneous pricing, it is also more volatile. The stock market and assets associated with the stock market tend to be more volatile than assets such as homes that are used to secure HELOCs. And, because most lenders are willing to lend according to the value of the account (at perhaps 65% of account as mentioned above), there exists the real possibility that in the event of a market downturn, the lender would require the borrower to add money to the investment account to preserve the value of the collateral or to pay down a portion of the loan. This cautionary note is particularly important to borrowers that borrow the maximum amount possible against the investment account.
Of course, a borrower should always be cautious about borrowing money and offering collateral to a lender. However, a line of credit based on the equity in an investment account can be a compelling alternative to a HELOC for those seeking additional access to liquidity.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.