The Power of Debt: It Isn’t All Bad

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Most people view debt as something to be avoided at all costs. But that’s because most people don’t use debt properly. A prime example of improper debt use is the credit card. People charge too much, fail to pay the card in full at the end of the month, then find themselves unable to pay down the debt without also paying exceedingly high interest, often for years.

However, some kinds of debt, such as a securities-backed line of credit, or SBLOC, can be helpful. They can even save or earn you money. SBLOCs are rolling lines of credit based on the value of assets in your accounts. They’re excellent ways to use debt to your advantage.

How Securities-Backed Lending Works

Borrowing money by collateralizing securities held in after-tax investment accounts is called securities-backed lending. The interest rate will often be lower than other types of loans, and you’ll generally get access to funds in just a few days.

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However, as with almost anything, there are caveats to taking out an SBLOC. While you can keep buying and selling securities in the collateralized account, you can’t use the loaned money for other securities-based dealings, such as trading or buying. And setting up an SBLOC will make it more challenging to move those collateralized assets to a different firm.

As an example of how SBLOCs can benefit you, suppose you need $75,000 for a one-time purchase of a car or a once-in-a-lifetime vacation. A typical way to acquire it would be to sell assets in a retirement account. That presents a number of drawbacks:

First, your income for that year would increase by $75,000 and could put you in a higher tax bracket and cost you a good deal of money next April.
Then, the increased income could trigger higher premiums for Medicare Parts B and D.

When you add up all the extra costs, you would spend around $93,000 for that $75,000!

If instead, you set up an SBLOC against a taxable brokerage account, then borrow the $75,000 from the SBLOC, you can amortize repayments over the next several years. This will allow you to avoid jumping up a tax bracket and prevent those extra Medicare costs. In the end, in this case, you could save around $13,500 by using an SBLOC. Plus, it allows you to still enjoy the advantage of owning the assets you otherwise would have sold.

Some Benefits to Securities-Backed Lending

The advantages of SBLOCs don’t end there; even if you’re not retired, they can enhance your purchasing power. A good example is buying a home. Especially in the last few years, the real estate market has been tight. Homes on the market often see multiple offers to buy. If you’re interested in a home that will likely attract bidding competition, you can make your offer stand out by using an SBLOC.

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Most homebuyers make offers contingent on financing approval. Even though your finances may be rock solid and you are not at risk of failing to get approval for a mortgage, that isn’t true of all buyers. Deals sometimes fall through due to financing, leaving sellers stuck trying to find another buyer. Therefore, some sellers may decline any offers with financing contingencies to avoid getting burned. By using an SBLOC, you can make a cash offer – no bank financing needed.

If the seller knows your offer won’t fall through due to financing, they’re more likely to accept it over contingent offers. Once you’ve bought the home, you can take out a regular 30-year mortgage and use the money to repay the SBLOC. It’s a good idea to verify that you will qualify for that mortgage before buying a home via an SBLOC, because if you fail to obtain a fixed-rate mortgage you may be exposed to rising interest rates, which can cost you a considerable amount of money.

Other benefits to SBLOCs include:

No setup fees.
Greater flexibility.
Amortization over several years can lower tax burden.

Some Downsides of SBLOCs to Consider

Of course, while an SBLOC can be a powerful tool for saving money or enhancing your purchasing power, it can also be misused. Some set up an SBLOC but are not emotionally prepared to have a large reservoir of credit from which they can draw. They spend frivolously, buying things like boats or sports cars, and only later remember that SBLOCs are not free money; what you borrow must be repaid! Plus, withdrawing from SBLOCs for ill-considered splurges reduces the SBLOC’s ability to help you save or make money through more reasonable purchases.

For these reasons, when we set up SBLOCs for our clients at Defined Financial Planning, we ask them to physically come into the office anytime they want to use their SBLOC to make a purchase. That lets us run the numbers for them to make sure it’s a wise use of debt or explain why it may not be the best decision for their finances.

Other downsides to SBLOCs to consider:

Variable interest rates.
Market losses could force the sale of some assets in the collateralized accounts, potentially exposing you to tax burdens and trading expenses.
Often, scheduled payments are interest-only. Borrowers must be disciplined and have a plan to pay off the principal.

The Bottom Line

Even after reading about the power of SBLOCs, you might be anxious about the idea of intentionally taking on debt. That’s understandable; as Americans, we’re conditioned almost from birth to view debt as dangerous to our finances and even shameful. However, when used properly, debt is a potent way to enhance your financial situation.

Using debt advantageously is a good thing, but it’s also complicated. That’s why it’s vital to work with an experienced financial professional to make sure it’s done properly. You want to find a professional who views it as their job to find ways to maximize your finances over time and help you navigate strategies for your unique financial situation, such as using the power of debt.

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The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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As Principal and Director of Financial Planning, Sam Gaeta helps clients identify financial goals and make plan recommendations using the five domains of financial planning — Cash Flow, Investments, Insurance, Taxes and Estate Planning. He is responsible for prioritizing clients' financial objectives and effectively implementing their investment plans and actively monitors the ever-changing nature of clients' financial and investment plans.