The power of debt: not everything is bad

The power of debt: not everything is bad

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

However, some types of debt, such as a securities-backed line of credit, or SBLOC, can be helpful. They can even save you or make you money. SBLOCs are revolving lines of credit based on the value of the assets in your accounts. They are great ways to use debt to your advantage.

How Securities-Backed Loans Work

Lending money secured by securities held in after-tax investment accounts is called a securities-backed loan. The interest rate is typically lower than other types of loans, and you’ll usually have access to the funds within a few days.

However, as with almost everything, there are caveats to taking out an SBLOC. Although you can still buy and sell securities in the secured account, you cannot use the borrowed money for other securities-based transactions, such as trades or purchases. And setting up a SBLOC will make it more difficult to move those secured assets to a different company.

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

When you add up all the extra costs, you’d spend about $93,000 for that $75,000.

If you instead set up an SBLOC against a taxable brokerage account and then borrow the $75,000 from the SBLOC, you can pay off the repayments for years to come. This will allow you to avoid moving up a tax bracket and avoid those additional Medicare costs. In the end, in this case, you could save around $13,500 by using an SBLOC. In addition, it allows you to continue to enjoy the advantage of owning assets that you would otherwise have sold.

Some Benefits of Securities-Backed Loans

The advantages of SBLOCs don’t end there; Even if you’re not retired, they can improve your earning power. A good example is buying a house. Especially in recent 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’s likely to attract competing offers, you can make your offer stand out by using an SBLOC.

Most homebuyers make offers contingent on approval of financing. Even though your finances may be rock solid and you’re not at risk of not getting approved for a mortgage, that’s not true for all buyers. Deals sometimes fall through due to financing, leaving sellers stuck trying to find another buyer. Therefore, some sellers may decline any offer with financial contingencies to avoid getting burned. By using an SBLOC, you can make an offer in cash, without the need for bank financing.

If the seller knows that your offer will not fail due to financing, they are more likely to accept it instead of contingent offers. Once he has bought the house, he can get a regular 30-year mortgage and use the money to pay off the SBLOC. It’s a good idea to check that you’ll qualify for that mortgage before you buy a home through an SBLOC, because if you don’t get 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 reduce the tax burden.

Some Disadvantages of SBLOCs to Consider

Of course, while an SBLOC can be a powerful tool for saving money or improving your purchasing power, it can also be misused. Some set up a SBLOC but are emotionally unprepared to have a large credit pool to draw from. They spend frivolously, buying things like boats or sports cars, only later remembering that SBLOCs are not free money; What you borrow must be returned! Also, taking money out of SBLOCs for thoughtless splurges reduces the SBLOC’s ability to help you save or earn money through more reasonable purchases.

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

Other disadvantages of SBLOCs to consider:

  • Variable interest rates.
  • Market losses could force the sale of some assets in the secured accounts, potentially exposing you to tax burdens and business expenses.
  • Scheduled payments are often interest only. Borrowers must be disciplined and have a plan to repay the principal.

The bottom line

Even after reading about the power of SBLOCs, you may be uneasy about intentionally going into debt. That is understandable; As Americans, we are conditioned almost from birth to view debt as dangerous to our finances and even embarrassing. However, when used correctly, debt is a powerful way to improve your financial situation.

Using debt to advantage is a good thing, but it’s also tricky. That’s why it’s vital to work with an experienced financial professional to make sure it’s done correctly. You want to find a professional who will watch as you work to find ways to maximize your finances over time and help you navigate strategies for your unique financial situation, like using the power of debt.

Director, Director of Financial Planning, Defined Financial Planning

As a director 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, investing, insurance, tax, and estate planning. He is responsible for prioritizing clients’ financial goals and effectively implementing their investment plans and actively monitors the ever-changing nature of clients’ financial and investment plans.

Appearances on Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm in preparing this article for submission to Kiplinger was not compensated in any way.

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