Portfolio line of credit: what is it and how does it work?
Borrowing against your investments is a line of credit option that many brokers offer exclusively to their clients. A portfolio line of credit can be either a margin account or a securities line of credit. A margin loan is an extension of credit from your broker that uses the securities you own as collateral. The funds can be used for short-term needs or to increase your investments.
A securities line of credit, unlike a margin account, cannot be used to purchase securities or repay margin loans and the funds cannot be deposited into any brokerage account. These are also known as nonprofit margin loans.
You are not familiar with this type of line of credit and you do not know on what type of funds you can borrow? Only funds in a taxable investment account are eligible; funds from tax-advantaged retirement accounts and cash accounts, among others, are not eligible for a portfolio line of credit. So if your funds are in an IRA, you are not eligible for a portfolio line of credit.
Here’s what else you need to know about a portfolio line of credit, including key risks to be aware of.
How a portfolio line of credit works
Each brokerage firm sets the minimum amount that must be invested in order to be able to borrow. Some companies only require $10,000, but other companies may require $25,000 or more. The percentage available to borrow also varies by company – 30% is typical, but some companies may allow you to borrow up to 60% of your total portfolio value. For example, if you have $10,000 in your account and your broker allows you to borrow up to 35% of the portfolio value, you can borrow $3,500.
Be aware that the minimum amounts and percentages available to borrow differ for margin and no-go loans.
Money borrowed on a portfolio line of credit can be used for many different purposes:
- finance a home improvement project
- buy a new car
- debt consolidation
- study cost
- business financing
A portfolio line of credit can be used as a supplement to traditional borrowing options such as bank loans and credit cards or as an alternative method of financing. Once approved, the money is accessible by checks, ACH or wire transfers usually in 1-3 business days. But some companies make the funds available in 24 hours or less.
Borrowing against your investments is usually a cheaper way to take out a loan compared to credit cards or bank loans because the loan is secured by collateral.
Advantages and Disadvantages of Using a Portfolio Line of Credit
- Your investments serve as collateral with your broker/lender, and since the loan is directly linked to your brokerage account, no credit check is required.
- Interest rates are lower than other forms of borrowing (and may be negotiable depending on the total amount of assets invested in the business).
- Spreads out a purchase over time, while allowing you to keep more of your investment for yourself.
- The money is available almost immediately because the approval process is easier.
- Does not trigger capital gains tax.
- No set repayment schedule, often with no minimum payments or prepayment penalties.
- May be subject to a high degree of risk: If your portfolio value falls below the minimum amount required for maintenance, you will either need to deposit more money to pay off the loan balance or deposit additional securities. If you don’t, your broker can sell the invested assets of their choice without contacting you. This is known as a margin call and can have significant tax implications.
- The required dollar amount held by the broker may be increased at any time without notifying you in advance.
- Eliminates your ability to “shop around for the best rate” unless you want to leave your current broker.
- Interest rates are variable and may increase at any time, especially when interest rates increase. Depending on market conditions, the cost of borrowing may exceed market returns.
- Possibility of “over-indebtedness” by borrowing too large a percentage of the value of your portfolio.
Is a portfolio line of credit right for you?
According to Wells Fargo Advisors, when leveraging your securities to meet a liquidity or capital need, be sure to consider whether the potential reward will cover the cost of borrowing and associated risks, as well as whether borrowing against your securities could have a negative impact on the performance of your investment.
Many fund managers recommend that clients establish a portfolio line of credit even if they are not using it, as it helps to have multiple borrowing options.
Alternatives to a Portfolio Line of Credit
An alternative option is a home equity line of credit (HELOC).
Things to consider when reviewing a HELOC include:
- The interest paid could potentially be tax deductible, making it an attractive option for financing home renovations.
- Interest rates are generally lower than credit cards and personal loans.
- Your home is your guarantee. Loans are considered second mortgages if your home is not paid off
- If you can’t pay your first and second mortgage, your home could be foreclosed
- HELOC applications take time to process because they require a home appraisal and a credit history review.
You can also use more traditional loans as an alternative to a portfolio line of credit, such as personal loans, auto loans, or credit cards.
At the end of the line
The annual interest rate for a portfolio line of credit generally varies depending on the amount of assets you hold with the brokerage firm, with rates generally being lower for those with higher account balances. Although interest rates have increased, these lines of credit can still offer some of the lowest rates to qualifying borrowers.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are cautioned that past performance of investment products does not guarantee future price appreciation.