How Title Loans Can Help Build Wealth
Securities lending (SBL) continues to grow in popularity as advisors and their clients increasingly recognize its tax efficiency, convenience and flexibility to meet short-term cash flow needs while maintaining a well-planned wealth. defined. Although selling assets is often seen as the only way to generate cash, access to and the ability to use a securities-based line of credit might be a better option for quick, short-term cash needs. .
The ABCs of SBL
It is important to understand the basics of equity-based lines of credit. Subject lines, commonly referred to as margin lines, are used to acquire investment securities to add to an existing portfolio. In contrast, N/A lines can be used for a wide variety of needs, including tax payments, tuition, automobile purchases, and home purchases or renovations, or other home purchases. non-investment related securities assets.
The amount of credit available for a N/A Line of Credit is based on an account collateral advance rate. This is very similar to a loan-to-value amount that banks are willing to lend when financing a home purchase through a residential mortgage. Advance rates for specific purpose lines of credit are limited to 50% of the account value, while non-specific purpose lines of credit may be higher depending on the use of the credit. Either way, establishing one of these lines of credit is very simple as the documentation required is very minimal. And unlike most other types of credit, credit approval is primarily based on the collateral value of the portfolio.
The other advantage of a title-based line of credit is its affordability. There are usually no fees to establish a line of credit, and the only cost the customer is likely to incur is an interest charge when the line is used. As these loans are secured by liquid collateral, the interest rates are generally economical, especially if you are using the line for short-term cash obligations. Most lines of credit have floating interest rates based on an index, such as prime rate or guaranteed overnight rate, with an appropriate spread.
Equity-based lines of credit versus asset sales
There are many reasons for having a title line of credit. An oft-cited example is the ability to avoid selling a property quickly or unnecessarily (and paying the corresponding taxes) in order to have quick access to cash. The timing of the sale of a security is important to a wealth plan, as is understanding the implications of incurring long-term capital gains taxes, recognizing unnecessary losses, and assessing the cost of capital gains. long-term capital. In addition, there is the opportunity cost. By liquidating assets on the stock exchange, for example, your client could miss out on larger returns.
The tables below show how these benefits could play out.
Securities-Based Lending vs. Mortgage Financing
An alternative to a title-based line of credit is a home equity line of credit or mortgage refinance. There are pros and cons to these alternative financing options. One of the advantages of residential mortgage loans is that the credit commitment is generally longer. This provides a long term fixed rate and some interest charges are tax deductible. On the other hand, the time from application to approval is longer than with a title-based facility. Additionally, home loan solutions require a significant amount of documentation such as tax returns, bank statements, and paychecks, and the bank performs an appraisal of the home. Alternatively, the biggest advantage of a title-based line of credit is the ease of qualifying and establishing that facility.
Market volatility: managing risk
It is important to know that these lines are not without risk. If the advance rate is too high and the value of the collateral declines significantly, the portfolio may be liquidated to pay off outstanding balances. It’s important to know the trigger points, or default rates, when this will happen, and to understand your bank’s system to provide notification if the advance rate becomes an issue. If a line exceeds the default rate and the lender sells assets to repay outstanding credit, this may result in tax consequences similar to those previously described. It is important for a client to closely monitor the line of credit against the value of the portfolio, especially in volatile circumstances or sustained market declines.
Look for a lender who will proactively oversee the relationship and securities lineup, as this could lead to early communication of any potential margin issues, which is especially important during periods of market volatility. The client and the wealth management team working together with regular contact are essential in order to explore alternatives to liquidation, such as adding additional unencumbered liquid assets to collateral, using cash surpluses to repay lines or liquidate assets that will result in minimal tax consequences. . Although automatic liquidation of assets is an option on these lines of credit, a lender may be able to work with the customer to avoid liquidation. Despite frequent communication between the customer and the relationship team, it should be noted that the responsibility for the credit remaining in the margin lies 100% with the customer.