Big Expenses: 4 Borrowing Strategies to Consider
Debt—used wisely—can be an important financial instrument that can help you pursue your goals, increase cash flow, and build long-term wealth. But not every instrument is right for every occasion or every person.
Here are four loan types to consider, depending on your needs—plus pros, cons, and other factors for each.
1. Margin loan
If you need cash to purchase securities or cover short-term expenses not related to investing, a margin loan may be worth considering. This type of loan requires you to have sufficient non-retirement investments in a brokerage account and allows you to use those securities as collateral.
How it works: You must apply to add margin to your brokerage account and must meet minimum balance requirements, since your investments serve as collateral. Once approved, you can borrow up to a certain percentage of your assets' value, typically 50%. Interest on the loan balance is calculated daily and posts to your account monthly.
| Pros | Cons |
|---|---|
| —You may be able to borrow with as little as $2,000 in cash or marginable securities. —There’s no set repayment schedule, as long as you maintain the required level of equity in your account. —You can potentially achieve greater investment returns by owning more securities than would be possible with the cash you have on hand. —Interest rates are generally cheaper than consumer lending options, like credit cards, and the interest may be tax deductible against your investment income. | —Using margin exposes you to potentially large losses. —If the value of the investments used as collateral drops by too much, you may face a “margin call,” which requires you to add more money or securities to the account. —If you fail to meet that demand, your brokerage may sell some or all the securities in your account—with or without your approval—to repay the loan. You may also need to pay taxes on any gains. —The interest rate is variable, meaning your borrowing costs may rise if interest rates increase. |
2. Securities-based line of credit (SBLOC)
Like a margin loan, this flexible line of credit allows you to borrow against the value of your pledged non-retirement investments. However, the funds cannot be used to buy additional securities.
How it works: You apply for a SBLOC with a bank. The amount of credit available is based on the value and type of assets you pledge as collateral for the line of credit. Once your assets are pledged as collateral, they will be held in a separate account to ensure the loan is properly collateralized and can be paid back.
| Pros | Cons |
|---|---|
| —An SBLOC allows you to meet immediate cash needs without selling investments, which can generate tax consequences. —Borrowing limits are often up to 70% of qualified investments—typically exceeding what margin loans allow. —Borrowing costs tend to be lower than other types of credit, because there are no setup fees or pre-payment penalties. —You may also enjoy greater flexibility with payments, such as paying interest only. | —These loans often require a minimum credit line of $100,000 or more, which may be more borrowing capacity than you need. —As with margin loans, a significant drop in the value of the collateralized securities may require you to deposit additional assets. —The broker could exercise its right to sell assets in the portfolio, if you aren’t able to meet this requirement, which may cause capital gains taxes. |
3. Mortgage or mortgage refinance
A mortgage is a great example of how using debt wisely can help you achieve important financial goals—in this case, owning a home. If you're already a homeowner, refinancing an existing mortgage into a new loan with a lower rate can also help free up cash to put toward other goals.
How it works: Your lender will first determine your creditworthiness and review your overall financial situation, which will affect your interest rate and the amount you're able to borrow. Once you're ready to buy a home, you must make a down payment to the lender—typically up to 20% of the purchase price—who will then loan you the funds for the purchase. You'll make regular payments, usually monthly, over a fixed period (typically 15 to 30 years). Each payment covers both the interest on the loan and a portion of the principal, which is the original amount borrowed. As you consistently make these payments, you gradually reduce the loan balance and build equity, meaning you own a larger share of your home.
| Pros | Cons |
|---|---|
—A mortgage allows you to purchase a home without needing all the money up front. —Interest rates are typically fixed, though adjustable-rate mortgages (ARMs) are also available. —Refinancing can help you reduce your monthly payments and/or pull cash out of your home equity. —Mortgage interest payments may be tax-deductible. | —A mortgage is a major financial obligation that may negatively impact your credit, if you fall behind on payments. —If your property value declines, you could owe more on your mortgage than your home is worth. —If you put down less than 20% of the purchase price, your lender may require mortgage insurance, which increases your monthly payment. —Interest payments add significantly to the overall cost of the home. —If you have an ARM, your borrowing costs could increase significantly, if interest rates rise. |
4. Home equity line of credit (HELOC)
Home equity is calculated by subtracting your outstanding mortgage balance from your home's current market value. While having more equity can give you more flexibility to fund other goals, such as a home renovation, big purchase, or debt consolidation, you should be strategic with its use since you are collateralizing your home.
How it works: If you have sufficient equity in your home (typically at least 20%), you can apply for a home equity line of credit with your existing lender or another institution. Once approved, your lender will set a credit limit that you can tap whenever you need it. Most HELOCs have variable interest rates, but sometimes you may be able to secure a fixed rate. You must make minimum monthly payments based on the amount you borrowed.
| Pros | Cons |
|---|---|
| —A HELOC allows you to tap the equity in your home without having to sell it. —Interest may be tax-deductible if the money is used to buy, build, or substantially improve your primary or secondary residence. —Interest rates tend to be lower than credit cards or personal loans. | —Because it’s secured by your home, failure to make payments on a HELOC could result in foreclosure. —If your interest rate is variable, your payments could increase over time. —Some HELOCs come with application and other fees, which can add to their cost. |
The bottom line
Understanding the nuances between margin loans, SBLOCs, mortgages, and HELOCs can help you find the right borrowing solution for your needs. Each instrument serves distinct purposes and carries unique risks and benefits that should be carefully considered, ideally with the help of a financial consultant.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Investing involves risk, including loss of principal.
The Pledged Asset Line is an uncommitted demand line of credit provided by either Charles Schwab Bank, SSB, or Charles Schwab Premier Bank, SSB. Entering into a Pledged Asset Line and pledging securities as collateral involves a high degree of risk. As a non-purpose line of credit, proceeds may not be used to purchase securities, pay down margin loans, or be deposited into any brokerage account. See schwab.com/PAL for more details. Before you decide to apply for a Pledged Asset Line, make sure you understand the risks. A Pledged Asset Line requires a brokerage account at Charles Schwab & Co., Inc.
When considering a margin loan, you should determine how the use of margin fits your own investment philosophy. Because of the risks involved, it is important that you fully understand the rules and requirements involved in trading securities on margin.
Margin trading increases your level of market risk.
Your downside is not limited to the collateral value in your margin account.
Schwab may initiate the sale of any securities in your account, without contacting you, to meet a margin call.
Schwab may increase its "house" maintenance margin requirements at any time and is not required to provide you with advance written notice.
You are not entitled to an extension of time on a margin call.
Home equity lines may not be used as a bridge loan, to finance a start-up business, to change the square footage of the collateral, to invest in securities, or to repay a Schwab margin loan. Second lien Home equity lines are only available with an eligible first lien Schwab invested loan. Loans are subject to credit and collateral approval. Additional terms and conditions apply. See schwab.com/HELOC for details.
This information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, you should consult with a qualified tax advisor, CPA, Financial Planner, or Investment Manager.