Sometimes a Traditional Bank-Financed Loan Isn’t the Best Fit
By Shane Cummings, CFP®, AIF®, Wealth Advisor & Director of Technology/Cybersecurity
From traditional real estate loans to innovative financial instruments, the lending landscape is diverse – including borrowing against your investment portfolio or retirement account.
In this article, we’ll delve into several loan alternatives along with their pros and cons. Understanding the characteristics and considerations of each option can help you make informed decisions about which type of loan aligns best with your needs and circumstances.
Margin Loans
Margin loans are a type of borrowing that enables you to leverage your investment portfolio. Essentially, you’re using your securities as collateral. As a basic example, you may be able to borrow up to 50% of the value of the securities in your portfolio. If your account is valued at $100k, you may be eligible to borrow up to $50k against those securities. The loan is open ended – as long as you continue to pay interest and don’t get a margin call you can keep it open indefinitely. Margin loans offer flexibility, enabling you to access funds quickly without selling your investments.
But they come with risks – such as potential margin calls and the need to repay the loan promptly if the value of what you’ve pledged as collateral declines significantly. If you have borrowed against securities aggressively, a market shock like we saw during the Great Financial Crisis or when the Covid crisis hit might would put margin borrowers in a difficult spot. In addition, newly purchased securities may not be eligible for a fixed time period after purchase, and you can only borrow against a portion of the total value of the security.
Securities-Backed Loans
Similar to margin loans, securities-backed loans leverage investments as collateral. Both of these options may also help the borrower avoiding having to liquidate securities, which can be a huge benefit if your securities have high amounts of unrealized capital gains that taxes would be owed on. These loans may have lower interest rates compared to other forms of credit, making them an attractive option for borrowers seeking liquidity while maintaining their investment positions.
As with any loan, it’s crucial to carefully consider the terms, interest rate, and potential risks before opting for a securities-backed loan. A securities-backed loan also typically allows for higher borrowing limits relative to margin loans based upon the underlying collaterals.
Traditional Real Estate-Related Loans
Real estate loans are a common choice for borrowers looking to purchase or refinance properties. These loans can take various forms, including fixed-rate mortgages, adjustable-rate mortgages, and home equity loans. Real estate loans often require collateral in the form of the property being financed.
Real estate lenders may also offer Home Equity Line of Credit (HELOC) products to borrow against the equity in your home. A HELOC loan may offer a better rate when compared to personal or unsecured loan rates.
Unsecured Loans
Unlike secured loans that require collateral, unsecured loans are not backed by specific assets. They’re typically granted based on the borrower’s creditworthiness, income, and other factors. Unsecured loans are versatile and can be used for various purposes, such as debt consolidation, home improvements, or personal expenses. But they generally carry higher interest rates to compensate for the lack of collateral.
IRA 60-Day Rollovers and 401(k) Loans
Individual Retirement Account (IRA) 60-day rollovers and 401(k) loans are borrowing options available to individuals who hold these types of accounts. IRA 60-day rollovers allow you to withdraw funds from your IRA and return the money within 60 days to avoid penalties and taxes. 401(k) loans allow you to borrow against your retirement savings – but you must repay the loan with interest.
These loan options provide short-term access to funds, but it’s essential to consider potential tax implications, early withdrawal penalties, and the impact on your long-term retirement savings. Due to all the considerable potential drawbacks, these types of loan options should be weighed carefully against other alternatives.
Each lending option has its own nuances, and some options are better than others given your specific borrowing needs and circumstances, as well as risk tolerance. It is not uncommon that borrowers don’t completely understand the risks inherent with a 401k loan or IRA rollover, so it’s important to consult your financial advisory team when looking at options. Some providers can offer better rates in a competitive situation and when you leverage your existing relationships with financial institutions. If you’re looking to borrow for a home purchase or a major renovation, a difference in interest rates can equate to large amounts of money over a period of time can really add up. Given we’re also in a much higher interest rate environment than we were a few years ago, evaluating borrowing costs is not trivial.
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.
