There are various ways to leverage wealth and one of those is through an asset-based or securities-based lending program. They are usually offered through banks affiliated with broker dealers. The rates themselves are based on the LIBOR or London Interbank Offered Rate plus a small spread. The overall variable loan rate is generally lower than conventional mortgages or loans and requirements are less stringent and not based on debt-to-income ratios but on the value of investable assets leveraged. Borrowers’ credit scores and the value of assets pledged will also affect the overall rate.
For over 40 years, the London Interbank Offered Rate has been used as a benchmark for setting the interest rates charged on adjustable-rate loans rather than the prime rate. The LIBOR is set each day by estimates from up to 18 global banks on the interest rates they would charge for different loan maturities based on the outlook of local economic conditions. As of 2019, there were over $1.2 trillion in residential mortgages and over $1.3 trillion in consumer loans. However, there is much talk that in 2022, the US will likely replace the LIBOR with the Secured Overnight Financing Rate (SOFR).
These loans cannot be leveraged against qualified retirement accounts like 401ks or IRAs, but they can be leveraged against other after-tax accounts like brokerage accounts. They also allow applicants to pledge up to 75-90% of a portfolio on cash equivalents or certain lower risk bonds, but most will call if over 50% of a loan value is borrowed on equities or an overall portfolio. It’s important to not be over leveraged because a call could create a worst-case situation where the borrower has to sell when the market is down to cover the loan. You should also make sure you would still be able to pay the monthly payments should something not go as planned like that sale of property or future windfall that you anticipate will cover the cost of the loan. These are different than margin loans and not for future investing. These are non-purpose loans for future purchases.
Let’s look at an example of how this might be used with a high net worth investor who needed $600,000 for a loan. Rather than selling investments and paying the 23.8% for capital gains (20% for LTCG plus 3.8% Net Investment Income Tax), they could look at loan closer to 2%. They could continue to pay monthly payments throughout the life of the loan or eventually pay it back over a short period of time as a type of bridge loan. Not only would that avoid the tax hit, but over a 15-year period, that $600,000 still is invested and has the chance at 6% to grow annually to over $1,400,000.
This has been coined the “bank of me” and interest in this has increased significantly over last year due to market performance. According to FINRA, asset-based or securities-based loans are up over 51% from a year ago. Banks are fans of these loans because it is a sticky business in that the client does not have to sell assets managed and they also receive additional loan interest and fees on the other side.
So, who would use these? If you are retired and have little income, these loans could be used as an alternative to a conventional mortgage. Mostly though, we see them used as types of bridge loans for buying a new home before you’re able to sell your current home. These loans could be used for other purchases like a yacht, antique car, art, or even to pay a large tax bill upfront before receiving an anticipated future windfall of cash.
At Wiser Wealth Management, we are not affiliated with banks and do not receive commission or fees from suggesting these loans. We can offer them through TD Bank and our custodian TD Ameritrade as an added value to high net worth clients when suitable. While we usually advocate the paying off of all loans including mortgages, there are some individuals for whom it may make sense to leverage assets rather than sell assets. If you have any questions, feel free to listen to our podcast on this topic or by calling us at 678-905-4450.
Matthews Barnett, CFP®, ChFC®, CLU®
Financial Planning Specialist