How the Wealthy Borrow Cheap Cash

Transcript of Podcast Episode 244

Hello this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode: How the Wealthy Borrow Cheap Cash.

Even the wealthy need to raise cash from time to time. A big tax bill, a major purchase, a wedding, or a college tuition payment are just some of the reasons. But they often do something that most people can’t: They borrow against their investment portfolio.

Let’s take a quick look at what some large investment account holders do. Programs vary from one bank, or investment advisory firm, to another, but investors with large portfolios can generally borrow at least 50% of their total account value. In fact, interest rates on these types of loans are generally lower than the rate on a personal loan or a home equity line of credit.

In effect, this type of loan allows a borrower to leverage their portfolio, using their securities as collateral, without having to sell their investments. Thus, they can raise cash without the transaction fees or capital gains taxes that may be due when selling some of their securities.

Does a securities-based loan make sense? The answer is: Sometimes. It only works well if you make more money on the investments than the interest rate you would pay on the loan.

This is certainly not for everybody. The risk of such a strategy should be obvious: You could be wrong about your portfolio. If it goes down while the loan is outstanding, you could end up losing a lot of money. Worse still, the lender can demand immediate repayment if there is a significant drop in the value of the assets that are used to collateralize the loan.

Interest rates on these types of loans are almost always variable. As with any variable rate, there is a risk that the rate could go up as general interest rates increase. The initial rate will vary from firm to firm, and rates are often tied to the amount of money you have invested at that particular firm. In most circumstances, the interest is not tax deductible.

How common is this strategy? According to a survey conducted earlier this year by Broadridge Financial Solutions, Inc., only about 5 percent of wealth management accounts are used to collateralize this type of loan. But Broadridge expects this percentage to double in the next three years.[1]

And how much money do you need to get started? The best rates are generally for account holders with a portfolio of at least $2.5 million.[2]

That’s likely too much for most investors.  But there’s an alternative that’s available even if you don’t have a big portfolio: their permanent life insurance policy. Some policy owners can use the ability to borrow against their life insurance policy to finance major purchases. Up to 90 percent or more of the policy cash value can be available quickly at a modest cost.

The idea is driven by a concept called “opportunity cost,” or the notion that whether you realize it or not, you finance everything you buy. If you use available cash to purchase a new car, you’re not going to pay interest on a car loan, but you are giving up the interest or dividends that the money would have produced for you.

One advantage to this strategy is that it can be done quickly and requires relatively little paperwork.  When borrowing against the cash value of a life insurance policy, the transaction can often be completed with one simple phone call. It is important to consider the policy loan interest rates which can be fixed or variable.

When it comes to your life insurance options, your Security Mutual Life insurance advisor can help you sort through your options and help get the process started. Your advisor will assemble your team and coordinate with your attorney and tax professional to review your situation and to determine the plan and strategies that are appropriate for you and your family. 

[1] Broadridge Financial Solutions, Inc. “Securities-Based Lending Industry Report 2023.” Broadridge.com.
.https://www.broadridge.com/_assets/pdf/broadridge-sbl-survey-report-march-2023.pdf. Accessed July 11, 2023.

[2] Wells Fargo Advisors Financial Network, LLC, “A Guide to Securities-Based Borrowing” wellsfargoadvisors.com. https://www.wellsfargoadvisors.com/why-wells-fargo/products-services/lending/securities-based.htm. Accessed July 11, 2023.

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The information presented is designed to provide general information regarding the subject matter covered. It is not to serve as legal, tax or other financial advice related to individual situations, because each individual’s legal, tax and financial situation is different. Specific advice needs to be tailored to your situation. Therefore, please consult with your own attorney, tax professional and/or other advisors regarding your specific situation.

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The applicability of any strategy discussed is dependent upon the particular facts and circumstances. Results may vary, and products and services discussed may not be appropriate for all situations. Each person’s needs, objectives and financial circumstances are different, and must be reviewed and analyzed independently. We encourage individuals to seek personalized advice from a qualified Security Mutual life insurance advisor regarding their personal needs, objectives, and financial circumstances. Insurance products are issued by Security Mutual Life Insurance Company of New York, Binghamton, New York. Product availability and features may vary by state.