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Securities Based Lending Frequently Asked Questions - What You Should Know
While securities based lending is certainly a strong investment option for many people, it is important to know exactly what it involves. By understanding how securities based lending works from the basics, you will be able to better understand the process, the risks and advantages and how this kind of investment is beneficial to your specific financial situation.
  1. What exactly is securities-based lending?
  2. What can I do with the loan funds?
  3. During the loan period, who will own the title for my stocks/securities?
  4. How will I get dividends on my securities during the loan period?
  5. What about appreciation, how will I get that if my securities appreciate in value?
  6. Why does securities based lending have such low interest rates?
  7. What is the upper limit for securities based lending?
  8. What happens if I default on my loan? Will it affect my credit rating?
  9. What is the ‘default trigger’ on securities based loans?
What exactly is securities-based lending?
In very basic terms, securities based lending involves temporary giving of a portfolio of securities in exchange for money. While cash is the most common thing exchanged for securities, they can also be lent out for government securities and letters of credit. There are numerous benefits to securities based lending, though it is not recommended for all kinds of financial portfolios. One main advantage is that the interest rates for the loans are not only fixed, they are also relatively low. These loans also do away with a number of extra fees and the amount can be for as much as 80% of the securities value. During this time, the borrower can still collect dividends and market appreciation from their stocks. At the end of the loan period, they can choose to pay off the loan, refinance or extend it. If you opt to end the loan, the lender will return the exact number of shares or securities that you borrowed against.
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What can I do with the loan funds?
The borrower can do whatever they like with the funds, provided that they do not purchase margin securities with the money. In some cases, the borrower may have to disclose what the money will be used for prior to the transaction being carried out.
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During the loan period, who will own the title for my stocks/securities?
During the loan transaction, the title of the securities does get transferred to the lender for that period. However, it is not considered a constructive sale and so it is not considered a taxable event. The borrower will also retain interests in the securities, which means they will still collect dividends, interest and appreciation on their securities.
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How will I get dividends on my securities during the loan period?
When the borrower gets a dividend on securities while they are on loan, the dividend will appear as a credit against the interest payments on this loan. This is generally done on a quarterly basis and any excess funds are sent to the borrower via check.
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What about appreciation, how will I get that if my securities appreciate in value?
At the end of the loan term, the lender will return the original shares that were borrowed. This will include any appreciation that the securities may have experienced during that time.
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Why does securities based lending have such low interest rates?
The reason for the low interest rates lies in the fact that the lender will not be sitting idle with your shares. They will be using them and trading them during the loan period. This is why they can afford to give low interest rates.
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What is the upper limit for securities based lending?
There is no upper limit. As long as the borrower can provide the needed collateral in their financial portfolio, the lender can provide money in exchange. However, these loans do have a minimum limit of $100,000.
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What happens if I default on my loan? Will it affect my credit rating?
A securities based loan is known as a non-recourse loan. This means that it is not recorded so if you do default on your payments, the lender cannot report you to the credit bureaus and they cannot come after you personally. However, in the event that you default on payments, you keep the loan amount and the lender gets to keep your securities.
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What is the ‘default trigger’ on securities based loans?
This is a provision set in place for the eventuality of the stocks or securities depreciating rapidly in value. This amount is set at 80% of the amount of the loan, not the securities value. If on a three-day average the value of the stock falls below this default trigger value, then the borrower is given two options. The borrower can use cash or other securities as contributions to keep the current loan viable. Or the borrower may simply keep the loan amount and the lender is allowed to keep the securities.
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