By the end of 2017, Elon Musk, the billionaire who owns Tesla, had pledged up to 40% of his stock in Tesla for securities-backed loans!
Although we don’t know why he did it or what he used the money for, we just know that he did it.
If a billionaire can be in need of quick capital, perhaps the rest of us should consider a securities-backed loan when we need some cash without selling our stock.
Read on to learn more about these loans.
What Are Securities-backed Loans?
A securities-backed loan is a loan against pledged securities, rather than the borrower having to put their physical assets up as collateral.
How Do these Loans Work?
To take out a securities-backed loan, the borrower transfers ownership of the pledged shares to the lender who owns the stock during the life of the loan. The amount the Lender will lend the borrower depends on the quality of the pledged shares
The borrower agrees to pay a fixed interest rate and the lender gives them the money. The lender earns any dividends issued on the loan stock while they own the stock.
In exchange, the borrower pays the agreed upon fixed-interest rate in installment payments during the term of the loan.
How Much Can Be Borrowed
The amount the borrower can borrow against their stock will depend on the broker and the features of the stock. The lender will take the following into account:
- How much is the stock is currently worth
- The number of shares being pledged as security for the loan
- How volatile they expect the stock to perform in the market
Because they are lending money based on pledged shares which can go up or down in price over the course of the loan, don’t expect to be able to borrow the full market value of the stock. The lender will have to pay the borrower less to cover their risk in case the stock price falls.
How Long Until the Loan Needs to be Paid Back
Depending on the lender, a borrower can get loans for different lengths of time.
But a borrower should be able to find a lender who will let them borrow money for one, two or three years.
What Happens if the Loan Defaults
If the borrower defaults (e.g. doesn’t pay the installment interest payments) on the loan, the lender can seize the pledged shares.
This means the lender will permanently own the stock the borrower transferred to them.
If the loan defaults, unlike other loans, there will be no negative hit to the borrower’s credit report.
Why People Use these Loans
People who need capital/cash fast at a low-interest rate find these loans attractive since the lender can get them the loan amount quickly and for less money than putting it on their credit card.
The lender won’t need to do a credit check and there is no negative credit report risk even if the loan defaults.
For more information about securities-backed loans, please contact us to speak with a specialist.
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