Learn what a portfolio line of credit is, its risks and benefits, and how it compares to other credit lines.
Portfolio Line of Credit Definition and Examples
A portfolio line of credit, also known as “securities-backed lending,” involves using securities as collateral for loans to investors. Lenders establish criteria for acceptable line-of-credit collateral. Eligible securities could be stocks or bonds, but they vary according how a lender values the offered securities. The borrower deposits the approved securities into an account on which the lender has a lien. In general, lenders approve amounts that range from 50% to 95% of the collateral’s market value. The exact amount loaned depends upon the value of the portfolio’s underlying assets—the investor’s valuation might be different from the lender’s. For example, if you were inquiring about a line of credit, a lender might approve you for $100,000, based on the value of the stocks you offered. However, after inspecting your portfolio, the lender might decide that you can receive a $190,000 line of credit if you offer $200,000 worth of U.S. Treasury notes as collateral instead.
Alternate definition: A loan given to an investor based on the value of the securities offered to the lender as collateralAlternate names: Pledged asset line, securities-backed line of creditAcronyms: PAL, SBLOC, PLOC
How Does a Portfolio Line of Credit Work?
Once an investor is approved for a line of credit and has deposited collateral in the lender’s account, they can access the funds. Generally, they can write a check against the line of credit or transfer the funds to a bank account. If the investment instrument’s value changes due to market conditions, the lender may require the borrower to deposit additional collateral—perhaps cash or other stocks and bonds, similar to maintaining a trading margin. The borrower can also repay some or all of the outstanding loan balance. If payments do not begin within a certain period known as the “cure period”—which could range from two to 30 days—the lender has the option to liquidate (sell) the investor’s collateral. Individuals and joint investors can establish portfolio lines of credit. Revocable living trusts in which the trustee, trustor, and beneficiary are identical, are also eligible. Depending upon the financial institution, loans can begin at $100,000 and reach into the multi-millions for high net-worth accounts. These loans have terms tailored to the borrower, with short and intermediate durations; five years is common.
Benefits and Risks of Portfolio Lines of Credit
Pros Explained
Lower interest rates: Compared to credit cards and traditional loans, portfolio lines of credit can have lower rates, because collateral is being held. Repayment flexibility: If an investor runs into trouble making payments, the lender can assist them by adjusting rates or payment terms. Cure period: The addition of a period where no payments are due helps investors plan for making payments. Reduced risk: For lenders, there is a reduced amount of risk. This reduction makes them more comfortable, because there is less chance of default. Low taxes: If you were to liquidate some of your investments, you would be hit with capital gains taxes. By taking out a loan, you access your assets without triggering taxes. Interest rates are lower than capital gains taxes.
Cons Explained
Market value drop: If the market makes a downward trend, your assets’ value might go down as well. This not only could lead to the lender asking for more from you, but there is a risk of significant losses if the market drops far enough—the possibility of owing far more than you borrowed exists.Loss of collateral: The lender can sell your assets if they feel there is a risk to their principal, such as late payments or a decline in value.Additional collateral might be required: Known to traders as a “margin call,” lenders can ask for more of your investments or cash to meet value requirements if investment values drop.Dividends: If you place a stock that provides dividends into the line-of-credit account, the dividends might be required to be routed to the account.
Portfolio Line of Credit vs. Home Equity Line of Credit (HELOC)
The tax advantages are different, because you can claim deductions for interest on a HELOC if the funds are used for home improvements or repairs. In a PLOC, you might be able to claim some deductions if you’re allowed to purchase taxable investments. Generally, this isn’t allowed in a PLOC, so the tax gains you receive are limited to reducing capital gains when accessing your investment funds. The Balance does not provide tax or investment advice or financial services. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.
