By Kyle Butz and Ashley Morales
It is easy to see why a security-backed line of credit (“SBLOC”) would appeal to people that need money fast. SBLOCs use assets held in one’s brokerage account as collateral and allow the investor to borrow money in the form of a line of credit. Firms market these loans as an easy and inexpensive way to obtain cash without having to liquidate their investments. Firms frame these loans as an attractive way to access capital when the market is doing well; however, market volatility can actually increase potential losses.
Unlike most loans, there are minimal restrictions as to how the SBLOCs may be used. Most SBLOCs only restrict the use of credit for trading securities. This provides the investor an enormous degree of flexibility. Many SBLOCs allow for an investor to borrow between 50% and 95% of the value of their underlying securities. Interest rates are typically lower than those found on a personal loan. Lenders will frequently even forego a credit check; the line of credit is issued solely on the merits of the underlying assets.
However, there are significant risks that an investor must be aware of before applying for an SBLOC. The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) have issued an investor alert regarding these lines of credit and strongly advise that investors consider the risks before opening an SBLOC. The primary risks include: variable interest rates which may even change daily, portfolio losses which adversely affect the investor’s line of credit and could result in the sale of the securities and subsequently tax consequences, and transferability issues. It is difficult to switch brokerage firms when an investor has an SBLOC. Generally, the investor will need to pay off the entire balance of the line of credit before transferring firms.
SBLOCs may be a great way to quickly and easily access money, but it is important to take the time to understand the risks and get answers to important questions about your account before assets are put forth as collateral. Investors should engage in extensive conversation and research prior to taking out an SBLOC.
For more information on Securities-backed lines of credit and their advantages and risks or for more information on this topic, please visit FINRA’s website.