By Shane Cummings, CFP®, AIF®, Wealth Advisor & Director of Technology/Cybersecurity
Borrowing Against Financial Assets
This article is for those of you who may want to borrow against your financial assets at some point. I’ll talk about two different options that we typically see used for borrowing against investment portfolios – that serve a variety of purposes.
Your borrowing might be used as bridge financing when selling a home and purchasing another over a short period of time, in order to avoid taking out a mortgage. Or it may be used to cover a large purchase, or to loan money to a family member. There are several options available for borrowing against investment assets, and they come with different advantages and caveats.
Securities-backed loans: Some key advantages
Let’s start with securities-backed lending. This type of borrowing requires a taxable investment account such as an individual brokerage account, joint account, or trust account. You pledge some or all of the securities as collateral with a lender and they approve a line of credit that can be borrowed against, subject to a credit check. You may be able to pledge up to 70% of the value of your securities as collateral. Once approved, you can draw on the line of credit and then make monthly payments on your loan based upon the amount of funds borrowed and the prevailing interest rate.
A securities-backed loan may involve low to no setup fees and doesn’t have a loan term like a mortgage, so it’s flexible relative to other options. As a borrower, you can set up your borrowing ability without actually setting a loan in motion – you won’t have to pay interest or make payments unless funds are withdrawn. This can be advantageous to have available even if you don’t utilize it. A securities-backed loan can also be less expensive relative to a mortgage because it doesn’t have the same type of origination fees as a traditional mortgage loan.
For an investor with a portfolio that contains highly appreciated securities, borrowing against them avoids having to sell them and incur taxable capital gains. In a hypothetical situation where a borrower is looking to borrow against their securities for a three-month period, it could cost less to make loan payments on a securities-backed loan than to liquidate appreciated securities and incur capital gains.
This especially applies if any of those gains are short-term and would be taxed at the borrower’s marginal federal tax bracket. So a securities-backed loan carries the benefit of allowing you to remain invested and not take those funds out of the market, particularly if the equity market is having a strong year and you don’t want to miss out on positive price appreciation.
Beware of aggressive borrowing with securities-backed loans
What investors do need to consider with a securities-backed loan is that aggressively borrowing against this line of credit can create issues if the market were to suddenly drop or go through a bear market.
For example, say you get approved to borrow up to $400,000 from your portfolio and you borrow $390,000. Then the market unexpectedly drops by 20%. The lender would require you to add funds to your portfolio to get the ratios back in balance or pay down part of your loan. Large market declines tend to be rare, but even so, it’s important to be aware of potential pitfalls such as these and plan accordingly.
60-day rollover rules: A nimble solution
Another borrowing alternative is available to investors with IRA assets. You can access funds from your IRA using the 60-day rollover rule. This method is prone to risks that should be weighed carefully.
Under IRA rules, investors can take advantage of a 60-day rollover once per 12-month period, aggregating both their traditional and Roth IRAs. As an example, if an investor has a $1 million IRA, and needed to borrow $400,000, they could withdraw that amount in cash from their IRA as a short-term loan, provided they re-deposit that amount before the 60-day window is up. The advantage with this method is that no credit checks or applications are required – and as long as the stocks or securities in the account are fully liquid, funds can typically be withdrawn quickly.
The disadvantages of 60-day rollovers
There are some factors to consider as potential downsides with a 60-day rollover. If for any reason the funds are not re-deposited within that 60-day window, the entire withdrawal is considered taxable to the account holder. That would mean the entire distributable amount is taxed as ordinary income and added to any existing income, which could push you into a higher federal and state tax bracket. Depending on your age, this could also impact your Medicare premium adjustments, which are based on your prior two years of recorded income. And it could trigger and/or expand your tax bill for the 3.8% Medicare investment income tax.
There is also the issue of those IRA funds being taken out of the market. If the markets are going through a positive growth period, you could miss out on potential asset growth. If, however, the markets are down, such as in 2020 during COVID’s impact, you could be dodging some potential market drawdowns. But keep in mind that the market is typically positive 70% of the time. So more often than not, investors are missing out on capital appreciation by taking funds out of the market.
Balancing Advantages and Risks When Borrowing Against Assets
These two options for investors definitely carry some strong advantages over traditional loans. They can make a significant difference in helping you borrow funds more efficiently and lower your fees. As I described above, though, they also pose hazards that you should consider.
We’ve assisted many clients in utilizing these strategies effectively. As always, your specific situation and the market environment should be evaluated with extreme care when contemplating securities-backed or 60-day rollover loans. If you have an interest in either approach or want to discuss specifics, please get in touch with your advisor team – we’d be happy to help.
Disclaimer:
Halbert Hargrove Global Advisors, LLC (“HH”) is an SEC registered investment adviser located in Long Beach, California. Registration does not imply a certain level of skill or training. Additional information about HH, including our registration status, fees, and services can be found at www.halberthargrove.com. This blog is provided for informational purposes only and should not be construed as personalized investment advice. It should not be construed as a solicitation to offer personal securities transactions or provide personalized investment advice. The information provided does not constitute any legal, tax or accounting advice. We recommend that you seek the advice of a qualified attorney and accountant.
The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without previous notice. There is no guarantee any forward-looking statement will come to pass. All opinions or views reflect the judgment of the author as of the publication date and are subject to change without notice. All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. This material should not be relied upon by you in evaluating the merits of investing in any securities or products mentioned herein. In addition, the Investor should make an independent assessment of the legal, regulatory, tax, credit, and accounting and determine, together with their own professional advisers if any of the investments mentioned herein are suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield may not be a reliable guide to future performance. Any reference to a market index is included for illustrative purposes only as it is not possible to directly invest in an index.
