Lenders often promote securities-backed lines of credit (SBLOCs) as an easy and inexpensive way to access extra cash by borrowing against the assets in your investment account without having to liquidate these securities. While SBLOCs might seem like an attractive way to access additional capital when markets are producing positive returns, these loans, which can be a key revenue source for securities firms (such as broker-dealers), carry several potential risks. These include unintended tax consequences, the possibility that you might have to sell your holdings, and the chance that market volatility could magnify your potential losses.
Here we share information about the basics of SBLOCs, how they might be marketed to you, and what risks you should consider before using the securities in your account as collateral.
What Are SBLOCs?
SBLOCs are a type of securities-based lending offered to investors. Other types include stock-based loan programs.
Set up as a revolving line of credit, an SBLOC allows you to borrow money using securities held in your investment accounts as collateral. An SBLOC requires you to make monthly, interest-only payments, and the loan remains outstanding until you repay it. You can repay some (or all) of the outstanding principal at any time, then borrow again later.
You can continue to trade in your pledged accounts; however, if the value of your securities declines to an amount where it’s no longer sufficient to support your line of credit, you’ll receive a “maintenance call” notifying you that you must post additional collateral or repay the loan within a specified period (typically two or three days). If you can’t meet the requirements, the firm can sell your securities and keep the cash to satisfy the maintenance call.
SBLOCs are non-purpose loans, which means you can’t use the proceeds to purchase or trade securities. However, an SBLOC still provides a fair amount of flexibility: Unlike some other types of loans that require loan proceeds to be used for a specific purpose, money from an SBLOC can be used to finance virtually anything—other than purchasing or trading securities.
What About Credit Limits?
A typical SBLOC agreement permits you to borrow from 50 to 95 percent of the value of the assets in your investment account, depending on the value of your overall holdings and the types of assets in the account. To qualify for an SBLOC, firms often require that both the market value of your portfolio assets and your initial withdrawal on an SBLOC meet certain minimum requirements. It’s not uncommon for a firm to require that your assets have a market value of $100,000 or more to qualify for an SBLOC.
In general, securities that are eligible to serve as collateral for an SBLOC include stocks, bonds and mutual funds held in fully paid-for cash accounts. The maximum credit limit for an SBLOC typically is based on the quantity and type of underlying collateral in your account. Credit limit determination varies by firm.
SBLOC funds may be available to you within a week from the date you sign your contract with the lender.
Interest Rates and Repayment
Interest rates for SBLOCs often are lower than those you'd be able to qualify for with a personal loan or line of credit from your bank or by using a credit card. In fact, some SBLOC lenders might not run a credit check and might determine your maximum limit solely based on the value of your portfolio. SBLOC interest rates typically follow the interest rate that broker-dealers pay banks for borrowing money that they, in turn, loan to investors, prime or SOFR (Secured Overnight Financing Rate) rates plus some stated percentage or “spread,” and you’ll be responsible for interest payments on an ongoing basis. Although interest is calculated daily, and the interest rate on your loan can change every day, it’s usually charged monthly, and the interest charged will appear on your monthly account statement. Some firms offer the option of a fixed rate SBLOC.
Weigh Potential Advantages and Risks
An SBLOC might allow you to avoid potential capital gains taxes because you don’t have to sell securities for access to cash. You might also be able to continue to receive the benefits of your holdings, like dividends, interest and appreciation. Some firms promote the flexibility of spending that comes with an SBLOC as a key feature or market SBLOCs as part of a retirement income strategy to fund short-term expenses.
However, as with virtually every financial product, SBLOCs have downsides. Just because you might qualify for an SBLOC loan doesn’t mean it’s a good choice for you. Take time to understand the risks and get answers to important questions about how this type of lending arrangement could impact your long-term investment goals.
10 Questions to Ask Before Taking Out an SBLOC
Before you use your assets as collateral for an SBLOC, take time to understand the risks, and get answers to important questions about how this type of lending arrangement could impact your long-term investment goals.
- What am I agreeing to? Make sure you fully understand the terms of any SBLOC offered to you and how the lending arrangement will impact your holdings, including potential tax consequences, maintenance call requirements and other costs. Know what aspects of the arrangement are out of your control. For example, your firm might decide that a security that was previously eligible as collateral for an SBLOC no longer qualifies. If this happens, your credit limit will be adjusted to reflect the change. You also might be required to post additional assets if the remaining eligible securities can’t cover the balance. In addition, some SBLOC agreements permit the lender to increase the percentage of collateral you must keep in your pledged accounts, which would require you to deposit additional assets or pay down the loan.
- Who’s the lender? Before you sign up for an SBLOC, understand who you’re doing business with. Many brokerage firms offering SBLOCs do so through a bank affiliate, so your investment professional might not be the point of contact for your loan. Make sure you know who to contact with questions about the SBLOC and ongoing account services. If your firm is offering the SBLOC for a third-party lending institution, ask your firm how they’ll continue monitoring your account and how and when you’ll be notified if a collateral shortfall or other issue might impact your assets.
- Should I use my investments as collateral? While SBLOCs’ low rates and quick access to cash might be appealing, remember that your investments might not be the best option for loan collateral. The prices of securities in your account are constantly shifting, which means that you might not have enough collateral to back your line of credit at times, thus triggering a maintenance call
- What if the value of my portfolio decreases? The firm might sell your securities if for example, the value of your securities declines sufficiently relative to the amount that you’ve borrowed. If the value of your portfolio declines and is no longer sufficient collateral for the SBLOC, the firm may require you to repay a portion of the loan or post additional collateral. If you’re unable to repay the required portion of the loan or post the additional collateral, the firm may sell some or all of your securities. The value of your holdings is always changing, so you can’t assume that the price today will be the price tomorrow. And keep in mind that SBLOCs are classified as demand loans, which means lenders may call the loan at any time.
- Does my investment mix matter? Consider the extent to which your portfolio is diversified. If your portfolio is concentrated in a particular stock or sector, a single market event could cause your portfolio value to plummet and trigger a maintenance call. Then you might be forced to sell your assets at the bottom of the market.
- What if the lender sells my securities to meet collateral requirements? You could have to pay capital gains taxes on the proceeds from these sales. Lenders often can make these decisions without giving you any notice. One way to protect yourself and your assets is to limit the amount you borrow. If you’re offered an SBLOC based on a high percentage of the value of your assets as collateral, consider taking less than what you’re offered.
- What impact will an SBLOC have on my investments? If the securities in your account typically receive dividend payments, determine whether those payments will be credited to reduce your loan balance and what, if any, circumstances will cause ownership of your holdings to change. In addition, certain account features may change with securities pledged for an SBLOC, such as check-writing privileges and recurring distributions.
- What about interest rates? If interest rates rise, it could cause a spike in the broker-call, prime or SOFR rates that apply to your SBLOC. Also, for accounts that have money market funds or bank sweeps, the amount owed in your account from the interest charge may be paid from redemptions, effectively reducing your cash or money market fund balances. Interest payments may be rolled into the balance, which, over time, can erode the value of your account or increase your indebtedness. In addition, depending on the interest rate environment, if you have a money market fund or cash in your account, you might be paying more in interest for your SBLOC than you’re earning.
- How is the seller compensated? Your investment professional might be paid based on a portion of the fees generated by your SBLOC. Some firms pay investment professionals on a quarterly basis depending on the size of your loan. Your investment professional also will benefit because you don’t have to sell assets in your account to pay for things with cash, which would diminish the potential fees and commissions that they could earn in the future.
- Can I move to a new firm if I have an SBLOC? It’s not as easy to move your assets to a new firm if they’re pledged as collateral for an SBLOC. To move, you’ll likely have to pay off the loan.
Financing opportunities come in all shapes and sizes. Remember to exercise caution and consider the risks before pledging your securities as collateral.