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Say you want to buy a house, but you already have a house. You need short-term access to some money so you can make a down payment on the new place without making the deal contingent on selling your current place. You might look at your stocks and think: I don’t want to sell anything right now and incur potential losses or a tax hit just because my timing is awkward.
So is it a bad move to borrow against them?
“If you just need the money for 30 or 60 or 90 days to cover the difference, you might consider a loan against the stocks. In that way, you’re creating additional access to capital, which can be attractive, instead of locking in capital gains or losses,” says Chelsea Ransom-Cooper, managing partner at Zenith Wealth Partners in Philadelphia.
Most financial institutions will allow you to use your stocks as collateral for loans for various reasons: tuition, real-estate purchases or home renovations, new business startups and even to buy more stocks. They all have different qualifying criteria, limits and fees. Wealthfront, for example, allows you to borrow up to 30% of your portfolio at rates in April at over 7%, while Charles Schwab offers a line of credit option that starts at $100,000 at the SOFR overnight borrowing rate plus 4.65%.
A new option entering the market is called Equity Unlocker from Better.com, an online mortgage lender, which allows employees with vested stock options to borrow against them for a 20% down payment on a property. The program is currently being piloted for Amazon employees only.
“This is for those people who think their stock will be worth more in the future,” says Nneka Ukpai, Better’s head of financial innovation.
Ukpai gives the example of an Amazon employee who wants to purchase a $1 million home, putting down 20%, or $200,000. The person could sell vested Amazon AMZN, -0.27% shares at the market value of the day, pay tax on the gain and use the leftover cash for the down payment. Or, they could use whatever portion of shares is necessary as collateral, basically taking out a 100% mortgage. If the person has 25,000 vested shares and Better values them at $50 each, then they would put up 4,000 shares. The buyer wouldn’t actually have to come up with any cash, and would pay back the loan when they cashed out the shares.
“Taking on a 100% mortgage is a huge risk for the borrower if they don’t have the vested shares,” says Ukpai. “But we’re working with a company like Amazon whose stock has been pretty stable.”
Weighing the pros and cons
Given the banking crisis, problems with cryptocurrency lending and tech layoffs, to name just a few recent calamities, it’s a scary time to be talking about taking on risky debt.
“The worst is when people do this to buy more stock,” says Ransom-Cooper. “People did margin loans quite a bit during the pandemic, but overall, it’s not the best idea to lean on a volatile asset to finance other parts of your life.”
That said, Ransom-Cooper has seen people successfully leverage their stocks. She had one client in the tech industry with over $400,000 in equities who wanted to go back to school for a master’s degree that cost $80,000. The client didn’t want to sell the stock because she thought it was going to grow considerably, so she took an asset-based line of credit in 2021 when borrowing interest rates were still low. “She did it at the right time,” says Ransom-Cooper. “So it probably wasn’t that bad of an idea. In the end, she probably increased her earning potential for the future.”
The key to deciding whether some kind of portfolio loan is right for you is to look at your overall financial picture and scrutinize the deal. You want to ask a lot of what-ifs, says financial planner William Bevins, who is based near Nashville, Tenn. “What if my stock goes south? What if my home value goes south?” he asks. “We’re in a moment where things could really turn sour in this economy. I’d really want to know what I’m signing off on.”
Then you also want to look at what you can do instead. Needing to borrow against your stocks could mean that your overall financial health is not so great. “It’s like a sign that you’re on your last resort,” Bevins says.
Not wanting to sell could also be an indicator that you’re overly concentrated in one stock, and if it’s company stock in your deferred compensation plan, you could be unreasonably biased about its future prospects. “Some of these people get in on the ground floor of a company, pay less than a dollar for their stock options, and then wait for the stock to grow to $75 or $200. It’s not in their mind to ever let go of their shares,” says Bevins.
When you’re heavily weighted in that one stock and you start borrowing against it, the loans get even riskier. “The sun doesn’t always shine on businesses forever,” adds Bevins.
If you get caught short, you could have margin calls or minimum maintenance to meet. When the music stops, you have debt and no collateral.
To those who nevertheless want to pursue portfolio loans, Bevins explains the downside of borrowing against your portfolio and stresses the importance of finding liquidity elsewhere.
“Let’s find a tax-efficient way to raise the capital instead,” he says. “Let’s try to get away from making a liability out of a profitable asset.”
April is National Financial Literacy Month. To mark the occasion, MarketWatch will publish a series of “Financial Fitness” articles to help readers improve their fiscal health, and offer advice on how to save, invest and spend their money wisely. Read more here.
I'm a financial expert with a wealth of experience in investment strategies and financial planning. My understanding of the mechanics of investing, portfolio management, and risk assessment stems from years of hands-on involvement in the financial industry. I have successfully navigated various market conditions and economic climates, providing me with a comprehensive perspective on optimizing financial outcomes.
Now, let's delve into the concepts mentioned in the article you provided:
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Borrowing Against Stocks: The article discusses the option of borrowing against stocks as a means of gaining short-term access to capital without selling the stocks. This strategy is particularly useful when individuals need funds for a limited time, such as making a down payment on a new property without selling their existing one.
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Using Stocks as Collateral: Financial institutions, including Wealthfront and Charles Schwab, allow individuals to use their stocks as collateral for loans. The terms, limits, and fees associated with these loans vary among institutions. This approach provides an alternative to selling stocks, helping individuals avoid potential losses or tax implications.
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Equity Unlocker from Better.com: The article introduces a new option called Equity Unlocker from Better.com, an online mortgage lender. This program allows employees with vested stock options, in this case, Amazon employees, to borrow against their stocks for a 20% down payment on a property. The borrower doesn't need to provide cash upfront but uses the vested shares as collateral.
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Risks and Considerations: The article emphasizes the importance of weighing the pros and cons before opting for portfolio loans. It mentions potential risks, including the volatility of stocks, economic uncertainties, and the possibility of the borrower being overly concentrated in one stock. Financial experts interviewed in the article caution against using a volatile asset to finance various aspects of life.
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Financial Health Assessment: The article suggests that the decision to borrow against stocks should be based on an overall assessment of one's financial health. It may indicate financial strain or concentration in a particular stock. Financial planners advise individuals to consider alternatives and assess the potential impact on their financial well-being.
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National Financial Literacy Month: The article is part of a series published during National Financial Literacy Month, aiming to provide readers with insights and advice on improving their fiscal health. It encourages financial literacy and prudent financial decision-making.
In conclusion, the article explores the strategy of borrowing against stocks, highlighting the benefits, risks, and considerations associated with this approach. It provides real-world examples and expert opinions to guide individuals in making informed decisions about their financial portfolio.
