The Pros and Cons of Pledged Asset Lines of Credit
A pledged asset line of credit (PALC) is a type of loan secured by the borrower’s investment portfolio. The borrower uses his or her investment assets (stocks, bonds, mutual funds, etc.) as collateral to secure a line of credit. In exchange, the lender provides a loan to the borrower based on the value of the pledged securities.
Here’s how a PALC typically works.
- The borrower pledges an investment portfolio as collateral to secure a line of credit.
- The lender (typically a bank or brokerage firm) calculates a percentage of the portfolio’s value that can be borrowed (generally around 50% to 70%). This percentage may vary based on the types of securities held in the account.
- The borrower and lender agree to specific terms (such as the interest rate, repayment schedule, fees, etc.).
- The borrower can access funds as needed, up to the approved credit limit.
- The borrower makes regular interest payments on the amount borrowed based on the agreed-upon loan terms.
As with most lending decisions, using your investment accounts as loan collateral has both pros and cons. It’s important to carefully consider all options before deciding to pledge your investments as collateral.
- Access to funds without selling investments – One of the most significant benefits of using a PALC is that it allows you to access funds without selling your investments. This can be especially important if your portfolio has appreciated, as it allows you to avoid capital gains taxes. By remaining invested, you’re also able to continue accessing market gains, preserving your long-term investment strategy.
- Lower interest rates –Because they’re secured by the value of an investment portfolio, PALCs tend to have lower interest rates than other types of credit, such as unsecured loans or credit card debt.
- Flexibility – PALCs offer flexibility in how borrowed funds may be used. You can use the borrowed assets to fund other investments, major purchases, home improvements, education expenses, etc.
- Ease of access – Once you’ve established a PALC, it’s relatively quick and easy to access funds, which can be beneficial in emergency situations.
- Market risk – The primary risk of PALCs is market volatility. If market fluctuations result in a decline in your account value, you may be required to repay a portion of the loan or pledge additional collateral to maintain the required loan-to-value ratio. This could require you to sell securities during a market downturn, which may be a difficult situation to recover from.
- Margin calls – If the value of your securities falls below a certain threshold, the lender may issue a margin call, which would require you to repay a portion of the loan or provide additional collateral. Margin calls can be stressful because they often require quick action.
- Credit risk – Although PALCs are typically only available to individuals with significant invested assets, they still involve a credit check. If you’re unable to meet your debt obligations, your credit score could take a hit.
- Interest – While the interest rates on PALCs are generally lower than those of certain other forms of credit, you’ll likely incur interest over the life of the loan.
- Investment limitations – Certain lenders restrict the types of securities you can pledge as collateral, which has the potential to limit your investment choices.
- Loss of investments – In an extreme circumstances, the value of your portfolio may drop to a point that you’re no longer able to meet the lender’s requirements. In this situation, you may face losing your investments if they’re sold to cover the cost of the debt.
Could you use some help deciding whether a pledged asset line of credit is right for you? Creative Planning can help. We work with clients to navigate a wide range of financial challenges. For help with your PALC, or any other financial planning challenge, schedule a call with a member of our team. We look forward to getting to know you!