How Does A Securities-backed Line Of Credit Work?

On Behalf of Ezell Law Firm, LLC

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Jul 16, 2023

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Business Law

In Louisiana, individuals can obtain credit through a facility that allows them to borrow against securities they own, called a securities-backed line of credit (SBLOC). The line of credit provides flexibility similar to a credit card. However, using an SBLOC comes with certain risks, and understanding this financial tool can help you decide on its suitability.

Defining a SBLOC

An SBLOC works as a revolving line of credit, allowing you to borrow money against a bundle of securities you hold in your portfolio. Lenders usually require collateral such as liquid, mainstream assets like stocks, mutual funds, ETFs or bonds. The maximum line of credit capacity depends on the value and volatility of your portfolio of securities, and lenders assign different weights to specific assets that consider their volatility potential.

You can borrow funds up to the credit line’s maximum, and as you make continuous payments to reduce the balance, you free up borrowing capacity like you would on a credit card. Interest is calculated monthly and charged on the current outstanding balance of the line of credit, not the maximum value.

SBLOC permissible uses

An SBLOC is categorized as a “non-purpose” loan, meaning you are not required to disclose how you intend to use the borrowed funds. However, you may not generally use borrowed funds for regulated investments or securities trading. Otherwise, you can use the loan funds for personal expenses such as home renovations, debt restructuring, medical bills or vacations.

Suppose you intend to use the funds to provide capital for your business, for example. In that case, it is essential to fully understand the risks for informed decision-making as it relates to business law and financial planning.

Risk of maintenance calls

An SBLOC carries certain risks, such as potential maintenance calls. A maintenance call happens if the value of your collateral falls to a level that no longer supports the line of credit. In this case, the lender may require you to repay the loan balance in full within a specified time frame, such as two or three days, or post additional collateral. Failing to meet a maintenance call can cause the lender to liquidate your portfolio to pay off the loan. You are still liable for paying the remainder if your portfolio proceeds do not cover the loan balance. Additionally, you may be responsible for capital gains taxes on the sale of the securities.

A securities-backed line of credit can provide an option for needed funds and an alternative to traditional bank loans. Understanding the risks can help you make the best financial decision regarding this type of credit.