7 Pros and 6 Cons of the Portfolio Line of Credit

By Chika

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Last Updated: September 5, 2022

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Investments are a sure way to secure our future. However, we may also need cash in the short term to solve some financial needs.

While most people usually resort to credit cards or other loans to meet their needs, borrowing against your investment is another option that you could explore when in need of cash. 

A portfolio line of credit is an option you can explore as an investor if you need to raise cash quickly. This article sheds a spotlight on this borrowing facility, including its pros and cons so that you can decide if this is a good fit for you when you are in a financial emergency. 

 

 

What is a Portfolio Line of Credit?

A portfolio line of credit allows investors to borrow against their securities through their taxable brokerage accounts. In other words, you can use your stock holdings and other investments as collateral for a loan while your investment stays in the market.

As such, you can keep investors receiving the benefits of your portfolio holdings, such as dividends, interest, and appreciation.

A portfolio line of credit can come in two forms - a margin account or a securities-based 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.

Also known as non-purpose loans, a securities-backed line of credit (SBLOCs) are generally more complex to obtain than a standard margin loan.

While margin loans are typically used for the sole purpose of investing in securities, SBLOCs cannot be used to buy securities, pay down margin loans, or be deposited into any brokerage account. 

A portfolio line of credit can be used as an alternative or supplement to traditional borrowing options such as bank loans and credit cards or as an alternative method of financing.

Once approved, money can be accessed through checks, ACH, or wire transfers typically within 24 hours, though some may take as long as 3 business days. 

To be eligible for a portfolio line of credit, you need to have funds in a taxable investment. Funds in tax-advantaged retirement accounts (such as an IRA) and cash accounts, among others, are illegible for a portfolio line of credit. 

 

 

How a Portfolio Line of Credit Works

The requirement for a portfolio line of credit varies in each brokerage firm.

Typically, there is a minimum amount that you need to have in your brokerage account to qualify for the loan. Some firms only require $10,000, while others may require $25,000 or more.

The percentage available to borrow also varies by firm. Some may require 30%, while others may allow you to borrow up to 60% of your total portfolio value. 

Be aware that minimum amounts and percentages available to borrow differ for margin and SBLOCs.

 

 

Pros and Cons of Using a Portfolio Line of Credit

Pros

  1. Your investments serve as collateral with your broker/lender. 
  2. Credit checks are not required since the loan is directly tied to your brokerage account,
  3. Interest rates are lower than traditional forms of borrowing. You can also negotiate for lower rates based on the value of securities you have with the brokerage.
  4. Even though your security is used as collateral, you can keep earning money from them, which could help to offset some of the borrowing costs.
  5. Money is available almost immediately as the approval process is simpler than traditional loans
  6. Does not trigger capital gains tax.
  7. There is no set repayment schedule,  minimum payments, or early payment penalties.

 

Cons

  1. You could lose your investments If the value of your portfolio falls below the minimum loan requirement and you are not able to deposit more money to pay down the loan balance or deposit additional securities. 
  2. If you get margin called, there could be significant tax implications.
  3. The minimum loan requirements can be increased arbitrarily by the broker without notification.
  4. A portfolio line of credit eliminates your ability to “shop around for the best rate,” since you can only borrow from your broker and at whatever rate they offer.
  5. Interest rates are variable and can increase at any time especially when interest rates are rising
  6. There is the risk of getting “over-leveraged” i.e. borrowing too large a percentage of your portfolio value. This could cause a margin call to be triggered and potentially lead to loss of securities. 

 

 

Is a Portfolio Line of Credit Right for You? 

Depending on your purpose, a portfolio line of credit may or may not fit you.

However, if you decide to use one, you have to undertake proper risk management. For one, the value of your security is not guaranteed, especially when the market is volatile. As such, you shouldn't borrow more than 30% of your portfolio. 

 

 

Bottom line

A portfolio line of credit can be a viable alternative to earning cash immediately at a low interest.

However, if you ignore risk management or due diligence, you could lose the investments that you have worked hard to grow. As such, it's best to keep your borrowing down to the minimum. This will reduce potential risks that may result from market volatility.

Photo by Gustavo Fring

 

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