Most people view debt as something to be avoided at all costs. But that’s because most people don’t use their debt properly. A prime example of misusing debt is the credit card. People overcharge, don’t pay off the entire card at the end of the month, and then find themselves unable to pay off the debt without also paying extremely high interest, often for years.
However, certain types of debt, such as an equity-backed line of credit, or SBLOC, can be helpful. They can even save you or earn you money. SBLOCs are continuous lines of credit based on the value of your account assets. These are great ways to use debt to your advantage.
How security-backed loans work
Borrowing money by collateralizing securities held in after-tax investment accounts is called securities-backed lending. The interest rate will often be lower than other types of loans and you will usually have access to the funds in just a few days.
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However, as with almost everything, there are caveats to taking an SBLOC. Although you can continue to buy and sell securities in the secured account, you cannot use the loaned money for other securities transactions, such as trading or buying. And having an SBLOC in place will make it more difficult to transfer those secured assets to another company.
As an example of how SBLOCs can benefit you, suppose you need $75,000 for a one-time purchase of a car or a one-time vacation. A typical way to acquire it would be to sell assets in a retirement account. This has several drawbacks:
When you add up all the extra costs, you would spend around $93,000 for that $75,000!
If instead you create an SBLOC on a taxable brokerage account and then borrow the $75,000 from the SBLOC, you can amortize the repayments over the next few years. This will allow you to avoid skipping a tax bracket and avoiding those extra Medicare costs. In the end, in this case, you could save around $13,500 by using an SBLOC. Plus, it allows you to still enjoy the benefit of owning the assets you would have otherwise sold.
Some advantages of securities-backed loans
The benefits of SBLOCs don’t stop there; even if you are not retired, they can improve your purchasing power. A good example is buying a house. Especially in recent years, the real estate market has been tight. Homes on the market often see multiple offers (opens in a new tab) to buy. If you’re interested in a home that might attract bids, you can make your offer stand out by using an SBLOC.
Most homebuyers make offers conditional on approved financing. Even if your finances are strong and you’re not at risk of not getting approved for a mortgage, that’s not the case for all buyers. Deals sometimes fail due to financing, leaving sellers stranded trying to find another buyer. Therefore, some sellers may decline any offers with financing contingencies to avoid getting burned. By using an SBLOC, you can make a cash offer – no bank financing is required.
If the seller knows your offer won’t fail because of financing, they’re more likely to accept it than conditional offers. Once you’ve bought the house, you can take out a regular 30-year mortgage and use the money to pay off the SBLOC. It’s a good idea to check that you will qualify for this mortgage before buying a home through an SBLOC, because if you fail to secure a fixed rate mortgage, you may be exposed to rising interest rates. interest, which can cost you a considerable amount of money. .
Other benefits of SBLOCs include:
- No setup fees.
- Greater flexibility.
- Amortization over several years can reduce the tax burden.
Some Disadvantages of SBLOCs to Consider
Of course, while an SBLOC can be a powerful tool to save money or improve your buying power, it can also be misused. Some set up an SBLOC but are not emotionally ready to have a large pool of credit to draw from. They spend frivolously, buy things like boats or sports cars, and only later remember that SBLOCs aren’t free money; what you borrow must be repaid! Additionally, withdrawing from SBLOCs for rash splurges reduces the ability of SBLOCs to help you save or earn money through more sensible purchases.
For these reasons, when we set up SBLOCs for our clients at Defined Financial Planning, we ask them to physically come into the office each time they want to use their SBLOC to make a purchase. This allows us to work out the numbers for them to make sure it’s a wise use of debt or to explain why it might not be the best decision for their finances.
Other disadvantages of SBLOCs to consider:
- Variable interest rates.
- Market losses could force the sale of certain assets in secured accounts, potentially exposing you to tax charges and transaction fees.
- Often, scheduled payments are interest only. Borrowers must be disciplined and have a plan for repaying principal.
Even after reading about the power of SBLOCs, you might be worried about intentionally going into debt. It’s understandable; as Americans, we are conditioned almost from birth to view debt as dangerous to our finances and even shameful. However, when used correctly, debt is a powerful way to improve your financial situation.
Using debt to advantage is a good thing, but it’s also complicated. This is why it is essential to work with an experienced financial professional to ensure that everything is done correctly. You want to find a professional who sees it as their job to find ways to maximize your finances over time and help you navigate strategies tailored to your unique financial situation, like using the power of debt .
The appearances in Kiplinger were obtained through a public relations program. The columnist received help from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.
This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SEC or FINRA.
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