Monday, January 17, 2011

Securities-Based Loan

Securities-based loan has gained popularity in today’s economy. It is using the securities as collateral to a loan. If you are one of the investors with solid stock investments such as Apple, Google or Citibank, it makes more sense to borrow against your securities than selling them today. This way, you have access to liquidity without immediately liquidating your securities and still maintain exposure to the market.

Lending against securities is not a new concept. It is also an option to traditional mortgage, in which Fannie Mae limits investors to finance up to ten properties. Securities-based loan is underwritten based not on the property you want to buy but on the stocks you own. This type of loan is also an ideal source of funds for foreign nationals and borrowers with undocumented income.

The loan is non recourse and is setup like a credit line with an attractive interest rate as low as 2.75% fixed interest only. However, if the stock value declines to less than the loan amount, the lender may require you to add additional collateral or repay part or the entire loan. Lender may also liquidate all or part of the securities, which may interrupt your long-term investment strategy. Since stocks are the collateral, the interest paid is investment interest expense, not a qualified home-mortgage interest. Read IRS Publication 550 for more detail on investment interest expense.

A Securities Based Loan is not a margin loan, and has significant advantages over a conventional margin loan. Regulated under Federal Reserve Board Regulation U, margin loan or purpose loan, is a loan backed by securities and used for purchasing other securities, subject to margin requirements. On the other side, non-purpose loan is a loan that can be used for any investment other than purchasing additional securities. Non purpose loan is not subject to margin requirements and typically carry lower interest rate.

If you are interested in this type of alternative loan, consult tax attorney.

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