Securities-Backed Lines of Credit: Are They Worth the Risk?
If you have a brokerage account, you have probably received a pitch from your broker for a securities-backed line of credit (SBLOC). Contrary to the flashy marketing brochure you may have seen, SBLOCs aren’t the best things since sliced bread. Know the facts before you consider one.
An SBLOC is a non-purpose revolving line of credit using the securities held in your brokerage account as collateral. “Non-purpose” means you do not have to use the proceeds for a specific purpose like you do with an auto loan or home mortgage. Basically, you can borrow cash against the value of your investment portfolio to finance basically anything from travel and college expenses to home renovations and buying a car. Pretty much the only thing you can’t do with an SBLOC is use the money to purchase or trade securities. This “easy money,” however, doesn’t come without cost or risk.
Typically, an SBLOC agreement will allow you to borrow between 50-95% of the value of your investment portfolio depending on the value of your overall portfolio and the types of investments in the account (i.e. stocks, bonds, etc.) The interest rates charged on an SBLOC usually follow the broker-call, prime or LIBOR rates plus some stated percentage. SBLOCs typically require you to make minimum payments every month, oftentimes the minimum payment is the calculated interest amount. Because the published interest rates fluctuate, the amount of interest you are charged daily may also fluctuate.
SBLOCs are “revolving” meaning you can access cash in various amounts, then repay it, and re-borrow more. The balance, therefore, can fluctuate like a credit card account.
Just like the balance of the SBLOC can fluctuate, so too will the value of the investments in your portfolio. If the value of the securities being used as collateral falls below a certain amount, you will receive a maintenance call notice from the firm instructing you to deposit additional collateral or repay the SBLOC – typically within 2 to 3 days. Otherwise, the firm will liquidate the securities in the account (sometimes at a loss) and keep the sale proceeds in order to satisfy the amount of the maintenance call. In addition to the potential for realizing a loss if the underlying securities values have dropped below their initial purchase price, if they have gone up in value and you realize a gain, there may be tax consequences.
SBLOCs can be a key revenue source for brokerage firms and they may be incentivized to sell them. This incentive to sell may mean they downplay the costs and risks associated with borrowing against your investments. Stockbrokers may receive additional compensation for selling SBLOCs to their customers. Stockbrokers also benefit because you don’t have to liquidate the securities in your account to generate cash, meaning they will still be able to earn commissions and/or advisory fees on those securities in the future.
If you decide to move your account to another brokerage firm, you will likely have to repay the SBLOC in full before you can transfer your account.
In conclusion, the key things to discuss with your broker before agreeing to an SBLOC are: How much is this going to cost me? How much are the firm and broker getting paid? What happens to my securities if the value of my portfolio drops? What happens if I want to move my account? What about changes in interest rates?
After you discuss these things with your broker, take a couple of days to think things over, don’t succumb to high-pressure sales tactics. You should also compare the costs and risk of the SBLOC to other available loans before you sign your name on the dotted line.