While most Americans have at least a passing understanding of the possibility of using home equity to obtain a low-interest loan with a home equity line of credit (HELOC), there is a lesser-known option of obtaining a quick line of credit financing that may offer more compelling benefits to some.
The financing option is available to individuals or businesses that maintain a non-retirement investment account and may offer lower rates than comparable HELOCs with the potential for faster processing times.
The key to getting a good interest rate on a loan comes down to having confidence that the lender will get paid.
Houses under pledge
To ensure certainty, the lender often requires collateral to secure payment. With a HELOC, the collateral is the home and the equity the borrower has in the home.
But foreclosed homes have some disadvantages for lenders. An appraisal is usually required to prove the home’s value to the lender. This can cost hundreds of dollars and take weeks.
In addition, to prove the existence of the lien, the lender often has to file documents with the local county auditor’s office, which also takes time and costs money. Finally, if the lender needs to seize the asset due to non-payment, the process can be time-consuming and expensive.
Some Americans have another asset ready to use as collateral for a line of credit: a non-retirement investment account. Due to the nature of the asset, the application process can be much faster.
Unlike a HELOC, no valuation is required because the assets in the investment account are valued daily by global markets.
Unlike a HELOC, the lender does not need to register the security interest with any local county auditor’s office.
For better or worse, if a lender needs to seize an asset due to non-payment, the process is also quicker and less costly for the lender. These benefits in many cases translate into cost savings for the consumer and the potential for faster processing times.
Like a HELOC, various companies offer lines of credit secured against the value of a non-retirement investment account.
Generally, interest rates are variable and may change monthly.
Repayment options are also flexible. The borrower can pay only the interest on the loan or can pay the principal at will.
When a person takes out a loan, the lender is given access to the investment account so that it can be used as collateral to secure payment on the loan. Although the lien (investment account) is secured in a similar way to how a HELOC is secured by a home, the process does not require filing with the county auditor’s office.
As a rule, the lender offers a loan of approximately 65% of the value of the investment account.
For those individuals who maintain investment accounts and have an account set up for a line of credit, access to financing is quick and easy. Typically, online access allows a borrower to request funds and transfer those funds to a linked bank account within one to two days.
For some, it can also be a comfortable source of liquidity in a pinch. Accordingly, it can also allow a person to feel safe by keeping a smaller amount of liquidity in savings accounts.
The disadvantage of a credit line based on an investment account is the volatility of the asset.
That is, while an investment account is easier to value due to instant pricing, it is also more volatile. The stock market and assets related to the stock market tend to be more volatile than assets such as homes that are used to secure HELOCs.
And since most lenders are willing to lend to the value of the account (perhaps 65% of the account as stated above), there is a real possibility that in the event of a market downturn the lender will require the borrower to add money to an investment account to preserve the value of the collateral.
This caveat is especially important for borrowers who borrow the maximum possible amount from an investment account.
Of course, a borrower should always be careful when borrowing money and offering collateral to a lender. However, an equity-based line of credit in an investment account can be a compelling alternative to a HELOC for those looking for additional access to liquidity.
Bo Ruff, a licensed attorney, is the director of planning at Cornerstone Wealth Strategies,
an independent, full-service investment management and financial planning firm in Kennewick.