If you don't want to sell stocks to pay for anything, you might want to take out a Security-Backed Line Of Credit, or SBLOC. With this tool, you can keep your stocks but still tap their equity.
At the end of the day, stocks have no utility value. You can't live in your stocks, drink your stocks, or enjoy your stocks. In order enjoy your stock gains, you need to sell. However, if you have stock gains, then you will have to pay capital gains tax, which is may be suboptimal.
Taking out a Security-Backed Line Of Credit is a solution.
Coming Up With Cash To Buy A Nicer Home
After real estate prices softened in San Francisco in 2022, the dream home I wanted to buy in 2022 came on the market again a year later. With an eight percent price cut, I wanted to buy the home. However, there was just one problem. I didn't have the millions in cash lying around! Further, I don't want to get a mortgage at a high interest rate.
In order to buy the dream home, I would need to sell a bunch of stocks, mutual funds, ETFs, and bonds. All this selling would result in heavy capital gains taxes.
Therefore, one solution to find liquidity was to get a bridge loan from my parents with the cash they already had lying around. Another solution was to sell my stock losers and bond losers to avoid paying capital gains. The final solution was to get a security-backed line of credit (SBLOC).
Let's discuss more about what is a SBLOC.
What Is A Security-Backed Line Of Credit (SBLOC)?
A security backed line of credit (SBLOC) is a revolving line of credit backed by “pledged” stocks or mutual funds. Similar to a home equity line of credit (HELOC), an SBLOC issues you credit that is “backed” by the asset of your stocks.
When you borrow from the SBLOC, you are usually charged an interest-only monthly payment until you pay off the full amount that you’ve borrowed. The interest rates go up and down with the market, but they are usually much lower than credit card rates and even personal loan rates.
SBLOCs are also called “pledged asset lines.” As “non-purpose loans,” they are supposed to be used to buy other assets or on other things except for stocks. Otherwise, you can just create a margin account to buy more stocks, which I don't recommend.
SBLOCs Are Popular Among Tech And Startup Workers
SBLOCs are particularly popular among tech workers or startup employees with Restricted Stock Units (RSUs) or stock options. The RSUs or stock options will eventually be liquid, but perhaps not during the time the employee needs liquidity to buy a house.
Before the bank runs at SVB and First Republic Bank, regional banks such as these two would regularly offer stock-based lines of credit to its customers. Most of the SBLOC was based off publicly-traded stocks, but some were also based off privately held stocks.
Imagine working for eight years at a startup like Stripe, which went from a <$50 million valuation in 2010 to over $50 billion today. But if you can't sell most of your stock to enjoy life and buy a house, then getting wealthy defeats the purpose. A regional bank offering a SBLOC on an employee's private Stripe stock is a solution.
SBLOCs are offered by banks and brokerage firms. Similar to the SBLOC is the HELOC, or home equity line of credit. Given there is the HELOC product already, SBLOCs are usually used by heavy stock holders who often don't have homes yet.
Positives Of A Stock-Based Line Of Credit (SBLOC)
Here are some positives of using a SBLOC to tap your stock equity.
- No need to sell your stocks
- No need to pay capital gains tax on your stocks
- By not selling stocks, you enable your stocks to potentially continue growing in value
If you want to get richer, you can follow what billionaires do and never sell assets. Instead, they borrow against the value of their assets to keep capital gains tax low and their assets growing.
As your stock portfolio's value increasing, you can increase the amount you borrow from a SBLOC and vice versa. Of course, the reverse is true in a bear market.
When you die, your stocks will undergo a “step up in basis.” Your heirs will inherit your assets at the fair market value at the time of your death without incurring capital gains taxes. The only caveat is that your estate has to be under the estate tax threshold, which changes every year.
For 2024, the estate tax threshold is $13.6 million per person.
Negatives Of A Stock-Based Line Of Credit (SBLOC)
The main negative of a stock-based line of credit is the cost to borrow against your stocks. The SBLOC borrowing interest cost might go up to 10%, depending on the Fed Funds rate and the 10-year Treasury bond yield. Interest rates are higher since the Fed starting hiking in 2022.
The second negative about using an SBLOC is that you might get a margin call if your stocks decline too much in value. If you’re borrowing from the SBLOC and the value of your stocks goes down, you might be forced to immediately sell securities. Losing a lot of money based on a forced sale margin call can be tough to stomach!
There's a one-two punch of paying an interest rate to borrow money and losing money in your stocks. The lender may force you to sell your stocks at a time you don't want to meet the margin call.
Example Of A Risk Using An SBLOC
Imagine if you borrowed $100,000 using a SBLOC for your Stripe shares in 2021. At the time, Stripe was valued at $100 billion and you paid a 5% interest rate. But in 2022, valuations of private tech companies crashed and interest rates shot up after the Fed started aggressively hiking rates.
In 2023, the private value of Stripe shares is worth only $50 billion. Meanwhile, your SBLOC interest rate is now 9%. The bank may ask for its capital back. Or it may ask you to pledge more Stripe stock collateral at a higher interest rate.
If you get margin called, you might not be able to choose which stocks to sell to cover your margin call. The brokerage may just pick some for you. After the forced stock sale, you might incur the very tax penalty that you were trying to avoid.
Also, while you’re borrowing against the SBLOC, you’re generally restricted from selling the pledged account. If you want to do that, you might need to either pay off the line of credit or get approval from the brokerage.
Here's some more information from the SEC about SBLOCs.
How Much Money Can You Borrowing Using A SBLOC?
Every online brokerage and bank is different when it comes to lending money using a SBLOC. The amount of money you can borrow depends on your existing relationship, number of accounts you have with the lender, the amount of assets you have with the lender, and your business potential.
Relationship pricing provides lower borrowing costs and more access to capital. But you need to have been a long-term client with top tier capital amounts before you can benefit from preferred treatment.
The SBLOC credit limit can range from 50% to 80% of the value of the securities. In other words, if you have a $1 million stock portfolio, you could potential borrow $500,000 – $800,000 using a SBLOC. It depends on how risky and volatile they think your stock is.
SBLOC Lending Amount Examples
Let's say you work for a publicly-traded cryptocurrency related company like Coinbase. Given the stock is highly volatile, the lender might charge you a higher interest rate. It may also limit your SBLOC borrowing to 50% of the value of your Coinbase stock.
On the other hand, let's say you work for a publicly-traded utility company with strong cash flow and a high dividend yield. The lender might lend up to 80% of the value of your securities.
If you own popular index funds or ETFs like SPY or VTSAX, many online brokerages will allow you to borrow up to 70% of the value of the funds.
You can pledge additional securities to the SBLOC to increase your credit line. Or you can wait for the market value of the stocks to increase over time to borrow more money. Of course, if a bear market hits, the reverse is true.
Be Careful Using An SBLOC To Buy Something You Don't Need
I'm considering opening an SBLOC to borrow money from my stock portfolio to pay for a dream house in cash. However, I don't need a dream house. Nobody does.
I can foresee a situation where I take out a 6.5% SBLOC and my dream house ends up with a lot of maintenance issues. Or, I might buy the house and proceed to lose my online income. Buying expensive things you don't really need with a SBLOC can be risky. This is the greedy part of us talking.
On the other hand, if you are using an SBLOC to pay for an expensive medical emergency that's life or death, then using one may be more appropriate. At the end of the day, you have to make a judgement call. How much risk and debt do you want to take using an SBLOC based on your net worth and future cash flow?
The reality is, I decided not to use a SBLOC and sell stocks and bonds to pay cash for my dream home in 4Q2023. After it came down 8% in price, it came down even more for a total decline of 14%. I basically got about $1 million off while my stocks rebounded by almost $1 million. So figured, why not take advantage.
The downside of selling so much stocks and bonds is that I'm no longer financially independent! As a result, I'll be doing some part-time consulting once my daughter goes to school full-time.
SBLOCs Grow In Popularity The Wealthier You Get
SBLOCs are more popular with the mass affluent and ultra-wealthy. But it's partly because wealthier people have more of their net worth tied up in illiquid assets.
Below is a great chart that highlights the net worth composition based on the level of wealth. Notice how the dark blue bar (business interests/equity) grows the wealthier the person gets. Business owners don't want to sell their equity, so they might turn to an SBLOC or something similar instead.
We've experienced the longest bull market since the Great Depression. Taking out a tax-free stock-based line of credit can be smart way to tap liquidity if you don't have tappable liquidity in a home already.
Just be prudent.
How To Open A Stock-Based Line Of Credit
The easiest way to open an SBLOC is to ask your existing brokerage or lender if they offer an SBLOC. If they do, then understand what are the SBLOC interest rates they charge.
If all is satisfactory, apply and open an SBLOC account. Then perform a “like-kind” transfer of your assets as collateral for an SBLOC loan.
Just like a HELOC, you can keep your SBLOC open and available whenever you need liquidity. When you aren't using your SBLOC, you want be charged an interest rate since you aren't borrowing any money.
The lender will check your credit and examine your application. If all checks out, your SBLOC should be accessible within a couple of weeks.
Institutions That Offer SBLOCS
Popular brokerages / banks that offer SBLOCs include E*Trade, Charles Schwab, JP Morgan, Wells Fargo, and Citibank. Fidelity is considering offering SBLOCs as well.
There are plenty of financial institutions that offer SBLOCs. All you have to do is ask your existing bank and search online.
Use An SBLOC As Liquidity Option
An Security-Backed Line of Credit (SBLOC) is a revolving line of credit backed by the value of your stock investment portfolio. It allows you to tap the value of your stocks without incurring tax payments for the capital gains of the underlying assets.
Instead of taking out more expensive personal loans or credit card debt to borrow money, SBLOCs offer lower interest rates. But in turn, you need the stock investment collateral and you need to be willing to get margin called. If you are forced to sell stock immediately to meet your margin call, you could end up losing more money with a SBLOC.
It's always good to have access to liquidity. The key is to not get temped by the liquidity and buy too many things you don't need. If you're comfortable with your cash flow, net worth composition, and future earnings power, then using a SBLOC is smart way to avoid paying capital gains taxes on your stock positions.
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