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Usually, when we think about the wealthy all-cash buyer swooping in on a real estate deal, it's a shadowy foreign millionaire (or billionaire) we have in mind. But, as The Real Deal recently reported, wealthy New Yorkers have found a way to get around the all-cash conundrum and stay competitive: taking out loans against their sizeable stock portfolios.
This kind of borrowing is known as a "non-purpose loan," or "securities-based borrowing," and is allowing more high-end buyers to get their hands on cash quickly, keeping the trend towards all-cash deals alive and well, TRD reports. And while it's not exactly a new practice, it's seen an explosion in popularity at big banks over the past couple of years. (These types of loans are also sometimes used by retirees who need quick access to cash, a practice financial experts tend to caution against—you'll see why, below.)
If you've got significant enough holdings for this to make sense, the setup sounds fairly ideal: non-purpose loans can be approved in a few days (as opposed to a few weeks, as with a home equity loan), and generally come with lower interest rates and none of the typical fees that come with standard personal loans or mortgages. On top of that, borrowing against investments allows buyers to keep them active in the market, and avoid the capital gains taxes they'd pay if they formally cashed in.
If this is all sounding too good to be true, there are also a fair number of drawbacks. Unsurprisingly, this kind of lending is higher risk than a standard mortgage, as buyers can be subject to expensive margin calls—in other words, required to put more money into their holdings—if values take a dip. Plus, the interest rates may come cheap, but they're also subject to change. "They're floating rates," Rolan Shnayder of Citizens Bank tells us. "As rates move up, so does the rate on that loan, as opposed to a standard mortgage rate that you lock in."
For this reason, buyers have been known to take out a non-purpose loan as a stopgap to get enough cash to close a deal, then go back after the fact to take out a traditional mortgage. "People like to separate their assets accordingly," says Shnayder, meaning that most investors prefer not to have the fates of their two biggest assets—their home and their investments— inextricably intertwined.
Plus, borrowing against your portfolio means you can't borrow against it for a different loan down the road, and who wants to preclude themselves from the possibility of a future flow of cash? As for the quick switch from a non-purpose to a mortgage, "it's easy," Shnayder says of the process. "The mortgage application has nothing to do with the loan they've taken out against their securities, so you get a standard mortgage, then just pay off the other loan."
There are restrictions to consider, too: non-purpose loans are generally available for assets that are over $1 million—you likely won't get one on a small potatoes portfolio—and how much you can borrow will depend on what kind of holdings you have (for instance, if you deal mostly in government bonds, which are comparatively stable, you'll be able to borrow against a higher percentage of your holdings).
Plus, stocks valued under $10 per share aren't generally eligible, one financial advisor told TRD, given that they tend to be more volatile, and "the banks want to protect you from yourself." These deals also expose banks to a great deal of risk in the event of a global downturn, to the extent that if this type of lending were widespread enough and the downturn bad enough, "it could even trigger another financial crisis," as TRD puts it. Oh, good.
For now, financial experts are calling for more regulations on and educations about these loans—Fortune has a helpful, if dire, explainer of the drawbacks that dubs these loans the "rich man's subprime"—so that borrowers don't get blindly led into deals that could come back to bite them later on. (After 2008, nobody's eager to go back down that road.) But if you're a buyer with major assets and the need to compete with the cash-laden competition, this may be a worthwhile option to make your assets a whole lot more liquid.
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