Looking to Buy a $1 Million Retirement Home, But Need a Short-Term Loan?

A unique product called a pledged asset line allows a person to borrow money for just a few months, letting their investments remain intact and saving on capital gains taxes.

A couple look wistfully at a large brick home.
(Image credit: Getty Images)

I recently worked with a couple who found their perfect retirement home. But they were remodeling the kitchen in their current house and it couldn’t sell it for a few more months, which would have given them the cash needed to buy the new home. Knowing their dream home wouldn’t be on the market long, they needed to act quickly.

They considered liquidating a brokerage account valued at just more than $1 million. But taking this course would mean they would owe more than $100,000 in capital gains taxes.

Instead, a short-term credit line called a pledged asset line of $900,000 was arranged. It served as a bridge loan to provide the funds to buy the new retirement home, covering their needs for approximately four months. Once the remodeling project was done, the proceeds from the sale of the original home paid off the loan balance.

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The loan’s interest cost was a fraction of the amount of money the couple would have paid in capital gains taxes if they sold their investments. In fact, the couple saved more than $90,000 by not selling their investments while their portfolio continued to grow during that time period.

Instead of tapping your investments for a quick cash infusion – and potentially paying tens of thousands of dollars in taxes – it may often make sense to borrow money by using a pledged asset line.

How It Works

A pledged asset line allows investors to borrow money by establishing an asset-backed line of credit. The proceeds can be used for any purpose other than to purchase more securities or pay down margin loans. They have flexible repayment options.

However, only certain assets can be used. These include after-tax brokerage accounts, revocable living trust accounts and other non-tax-advantaged accounts. Funds in individual retirement accounts (IRAs) – including Roth IRAs – qualified plans and health savings accounts will not be considered.

A bank will determine how much it is willing to lend based on the value of these investments. For example, lenders may lend up to 90% on certain bonds and cash and more than 50% on individual stocks. The more stable the investments, the more banks are willing to lend.

For instance, lenders will offer a larger amount for accounts holding certificates of deposit or corporate bonds. Riskier assets, such as alternative investments or junk bonds, will offer increased uncertainty to lenders, and therefore, they will be reluctant to lend more.

To approve these loans, banks often require a person or couple to establish a minimum credit line, as well as a minimum amount to be withdrawn. After the initial draw, subsequent draws can be made for smaller amounts up to the maximum amount approved by the lender.

There are no application or account maintenance fees associated with a pledged asset line. There are monthly interest payments, much like how a mortgage or home equity line of credit (HELOC) would be repaid.

The interest rate is typically tied to a benchmark rate, like The WSJ Prime Rate or 1-month LIBOR (London Interbank Offered Rate), plus an interest rate spread. The interest rate spread can vary depending on the value of your portfolio. Because current interest rates are so low, a lender may impose a minimum interest rate, called a floor rate.

When the couple mentioned above applied, they were able to secure an interest rate of 2.35%. Compared to their quoted HELOC rate of 3.5%, they were able to save over $500 per month on their repayment.

Most of these loans are paid off within 12 months. There are no maturity dates or prepayment penalties, so the borrower doesn’t have to worry about paying off the loan too quickly.

When you are ready to start paying down your loan, simply write a check or set up an ACH or wire payment. You can even direct the interest and dividends generated from your portfolio to help pay down the loan.

What are the risks?

While there are plenty of benefits, there also certain risks to consider before applying for a pledged asset line.

Before tapping the full line amount, you need to understand the potential for your investments to lose money. If your account balance drops below a certain amount, the lender may require you to make a lump sum payment.

For example, if a couple were to receive a pledged asset line of $1 million based on their $2 million pledged account, then they must keep the account balance above their current outstanding credit lines. If the pledged account were to fall below $1 million due to investment losses, the lending bank would require them to eliminate the deficit. This would either be done by selling the assets within their pledged account to repay the loan or by depositing the shortfall into the pledged account in order to meet the collateral requirements.

The lender also holds the right to sell securities within this account without consent or notification. If you are unable to come up with the funds to pay down the loan, the lender may be forced to sell your investments, which could cause unforeseen tax consequences. And the borrower has no ability to determine which securities are sold.

In addition, it’s not as easy to take money out of a pledged account. If you would like to remove money from your account that is not being used as collateral, you need to get approval from the lender.

Lastly, minimum interest payments are due on a monthly basis, and investors may incur additional fees for late or missing payments if the interest is not capitalized.

The Bottom Line

A pledged asset line can provide enormous benefits for investors. However, the details can be complex, so consult with a financial adviser before proceeding. In most cases, these asset-backed credit lines work well as a short-term tool to help cover major purchases. And by quickly repaying the loan, a person or couple could possibly save tens of thousands of dollars while keeping their investment positions in place.

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.

R. Jason Rogers Jr.
Wealth Planner, McGill Advisors, a division of Brightworth

R. Jason Rogers Jr. is a wealth planner with McGill Advisors (opens in new tab), a division of Brightworth. Based in Charlotte, Jason helps build comprehensive wealth plans to provide financial clarity among business owners and corporate professionals. He graduated from Gardner-Webb University with a degree in Business Administration and also holds a master’s degree in Wealth and Trust Management.