When looking for loan options, you may come across security-based loans, also called securities-based loans.
Security-based loans (SBLs) can mean a few things depending on what lender/ loan type you are looking into. First and foremost, security-based loans are usually referred to as loans for those who want to make large purchases, such as taking over a business or going through multiple real estate transactions.
You may also sometimes hear security-based loans when dealing with secured, cosigned, and co-borrowed loans, even though, technically, these are different loan products.
Continue reading to learn more about these types of loans.
Details on Securities-Based Loans (SBLs)
When referring to a security-based loan, in most cases, it will mean a loan to acquire extremely valuable assets/investments. As mentioned above, this loan can acquire multiple corporations, luxury goods, properties and land, cars, etc. These loans can be found at financial institutions like banks, credit unions, brokerage firms, and advisory firms.
With these loans, lenders will look into the borrower’s investment portfolio (sometimes standard income and credit if needed) to make a lending decision. If the borrower cannot pay, the financial institution/lender can sell securities from the portfolio to get their money back. And so, with an SBL, the pledged securities with a loan are a large part of the approval process.
The types of collateral your lender may accept as a part of your portfolio can include the following:
- Mutual funds.
- Hedge funds.
- Certificates of deposit.
- Treasury, municipal, and federal government agency bonds.
- Exchange-traded funds.
- Stocks.
- Cash equivalents.
Most any other type of investment account will likely be accepted.
Security-Based Line of Credit or SBLOC
Security-based loans can also be offered as a securities-based line of credit. An SBLOC can make it possible to borrow cash as you need, which can be great if you are an investor. This allows you to take advantage of different opportunities so you can invest when the time is right.
Depending on the type of investment accounts you have, you will have to use the according account as collateral. For example, if you have stocks, you can use the investments from your taxable brokerage account as collateral for your revolving line of credit. Securities-based lines can work better than securities-based borrowing for those who aren’t sure exactly how much or where they want to invest.
With a credit line, it also may be easier to avoid investment risks, as it can be less tempting to spend all your funds right away, enabling you to research before putting your money in.
Securities-Based Loan vs. Securities-Based Lending
Now that you know about security-based loans, it will be helpful to learn more about securities-based lending.
Securities-based lending is different from a security-based loan. With securities-based borrowing, instead of pledging securities as collateral, the borrower will have to offer cash or letters of credit in order to get funding. Usually, investors are involved with these loans and often trade securities, essentially one kind of peer-to-peer lending.
Some Advantages and Disadvantages of Security-Based Loans
Just like any loan product, there will be some advantages and disadvantages of securities-based loans. Here are some things to keep in mind before deciding to take out one of these loan options:
- With these loans, you can avoid taxable events—any event that means having to owe the government taxes—and it can be a great way to invest without those penalties.
- An SBL can make cash available reasonably quickly. Once approved, you could see the cash in about three business days.
- The interest rates for these loans are highly competitive.
- When it comes to property, an SBL can have less risk than a second mortgage.
- SBLs do carry a risk based on market trends, which could mean losing your portfolio.
- You may be subject to a margin call if your portfolio drops under a certain amount.
- If your lender liquidates any part of your portfolio, you may face tax implications.
- They are not as regulated as traditional loan options.
- You may not have access to your entire portfolio.
Strategy Is Key With Security-Based Lending
At the end of the day, security-based lending is more of investing than it is borrowing money. And so, just like any other investment, there is risk involved and it is best to go in with a strategy. Many people use financial advisors or experts to help them through this process, which does not guarantee things will go smoothly. Still, it can definitely lessen the risk of a bad investment with your loan options and the loan funds used afterward. And so, if you don’t have a ton of experience with these loans, it is best to start with an expert.
Loans That Are Technically Not Security-Based Loans but May Be Referred to as Such
You may hear the following loan options referred to as security-based loans, even though they are technically not the same as the loans listed above. They do have the same essential requirement, though, needing some type of collateral or security to make the funds available. These loans are secured loans and loans with a cosigner or co-borrower. Continue reading to learn more about these loan options.
How Do Loans With Collateral / Secured Loans Work?
You may sometimes hear secured loans referred to as security-based loans. With secured loans, you will have to offer something of value to the lender as security. That way, if you cannot repay the loan, they can sell that asset to get their money back. Some common assets used for a loan include a home, a car, a boat, and jewelry. Once you repay the loan in full, you will get the rights to the asset back and, in some cases, get it physically back as well.
For loans that require collateral, the asset will need to be worth the loan amount, so the lender has security if you cannot repay the loan.
And so, if you take out a secured loan and cannot make your payments or break any terms of the loan agreement, you risk losing the collateral.
The Opposite of Secured Loans—Unsecured Loans
Loans that do not have any collateral are called unsecured loans. These are the most common types of loans; chances are you have taken out one of these before or applied for one. With these loans, the lender will trust that you can repay them based on your creditworthiness, so they don’t need to worry about asking for collateral. Typical unsecured loans include personal loans with steady monthly payments and credit cards. Interest rates for these loans will be lower than secured lending.
Why Do People Seek Out A Secured Loan?
Many people seek out secured loans because they likely have struggled to find an unsecured loan option due to their credit score/credit history or lack thereof.
If you are someone who is just starting out with credit accounts, then chances are you don’t have a lot of credit history a lender can check out. On the other hand, if you haven’t had the best financial circumstances, then your credit score may be low. Both of these things will make it hard to access funding through traditional unsecured loan options. And that is where secured loans come in.
How Does a Cosigned Loan Work?
Another form of a security-based loan you may hear referred to can be a cosigned loan. In this case, the cosigner will be the security for the lender if you cannot repay it. Cosigners will need to have good credit and income in order to provide help for credit approval. If the primary borrower cannot repay their loan, the cosigner will have to step in and take on that responsibility. Both parties will have to fill out an application and send in their credit documents. And all actions on the loan will impact both people’s credit scores.
How Does a Loan With a Co-Borrower Work?
A co-borrower is someone you can add to a loan who will be equally responsible for repayment from the get-go. If an asset is involved with the loan, both borrowers will have equal ownership. If one borrower misses a payment, the other will have to make up for that, along with their portion of the monthly payment. Unlike a cosigner who may be a friend, co-borrowers usually share their finances and are usually a parent or a spouse. You’ll often find co-borrowers with mortgage loans and car loans. Like a cosigned loan, both parties will have to apply, and their credit scores will be impacted by loan repayment/actions.
The Bottom Line With Security-Based Loans
Security-based loans, also called SBLs, allow borrowers to use their investment portfolio as collateral to make large purchases or investments. They can be available as lines of credit as well. Generally, investors seek out these loans rather than the average consumer. Just like any loan product, these loans have some risks, but when done correctly can mean acquiring more wealth and additional investment opportunities.
References:
What Is Securities-Based Lending? | U.S. News
What Is Securities-Based Lending?| Experian
