The Value of Debt in Building Wealth

Appendix B

Understanding the Power of Securities-Based Lending

Securities-based loan (SBL) facilities allow you to borrow against liquid investable assets to finance almost anything except the purchase of additional securities. They offer many advantages and better terms: rates under prime, no amortization, no required monthly payments, no cost to establish or maintain, and limited underwriting. If you have $300,000 of qualifying investable assets, you could put an SBL in place with a maximum loan of $150,000—though you should never draw more than 50 percent of your available line, or $75,000 in this example.

How does this work? Suppose you just got a bonus and need a new car. You have your eye on a $40,000 car. Your first impulse—like most people's—is to get a 4-percent loan with a four-year amortization schedule, resulting in a monthly payment of about $900 per month. Those terms stink.

Instead, you could put the $40,000 on your SBL at a cost of about 4 percent. You would pay about $1,600 a year, or $133 a month, in interest ($40,000 × 4% = $1,600/12 = $133 per month), as opposed to roughly $900 a month.

Is this an apples-to-apples comparison? Not exactly, because the amortized loan includes a principal payment. But you can never underestimate the financial flexibility that a lower monthly payment provides. You can pay down principal whenever you want. The key is that you—not the bank—are in control of the payment schedule. You're not tying up capital in a depreciating asset. ...