Personal Finance

Money Matters: Ask these questions before taking out a securities-backed loan

Q. Our broker proposed that my wife and I invest in something called a securities-backed line of credit or going on margin. We were telling him about needing some cash for what we hope is a short-term need and we’d rather not sell our stocks/funds in this crazy market. We’ve already maxed out our home equity line so we figured that selling some of our investments even though the market is down was our only option but these options sound like a good idea. We’d appreciate your thoughts.

A. How timely. The latest version of the N.C. Department of the Secretary of State Securities Division’s newsletter contained a great explanation from the Financial Industry Regulatory Authority and the Securities Exchange Commission on the basics of securities-backed lines of credit (SBLOCs). I’ll provide a condensed explanation of SBLOCs below. You and other readers may want to subscribe to this newsletter; it is very informative about a variety of investment topics, including the latest scams of which to be aware. To subscribe just contact John Maron, Director of the Secretary of State’s Investor Protection & Education Services Program at: The N.C. Secretary of State’s Office also has a hotline you can call before making an investment to find out if the investment opportunity itself and the person offering it are properly registered, and whether the person offering the investment has a disciplinary history. The N.C. Securities Hotline is 1-800-688-4507. In addition to calling before making new investment decisions they also advise people who’ve worked with the same investment adviser or broker for years to occasionally check the disciplinary history of that person.

SBLOCs and margin loans are similar in that you borrow money and agree to use your investment account assets as collateral. With both of these loans if the value of your security account declines, you will receive a maintenance call. A maintenance call will require you to post additional collateral or repay the loan within a few days. If you are unable to do either of these, the firm has the authority to liquidate your securities and keep the cash to satisfy the maintenance call. Margin loans will usually have a requirement that a maximum of 50 percent of your account value can be borrowed. SBLOCs usually allow you to borrow a higher percentage of your account. The interest rates on both loans typically follow a published rate such as LIBOR or Prime plus some stated percentage. Margin loan interest rates are usually higher than SBLOCs.

The newsletter offers 10 questions to ask before taking out an SBLOC; these same questions would be appropriate for a margin loan. 1) What exactly are you agreeing to? Know the terms, tax consequences, maintenance call requirements and all costs. 2) Who is the lender? Is it your brokerage or advisory firm, one of its affiliates, a clearing firm or a third-party lending institution? You want to know your point of contact for your loan. 3, 4, 5 & 6 ) All have to do with should you use your investment as collateral for a loan? Just know that if the market declines you may need to be prepared to sell your investments at the most inopportune time - while the market is down. If your investment mix is concentrated in one sector (oil) or stock (linkedin) you may be forced to sell at a price at which you never dreamed of selling. 7) What happens with dividend payments? Can you still write checks and have automated payments from your account? 8) How are interest rates determined, how often do they change? 9) How is my broker or advisor compensated if I take a loan? 10) Can I move to a new firm if I have an outstanding Margin or SBLOC?