Emergency cash reserves: Have you considered this lesser known line of credit?
As 2020 winds down, there’s reason to hope the worst phase of the pandemic-created recession is behind us. Yet no one will soon forget the economic strain this caused.
In my conversations with private-banking clients, a topic coming up frequently is emergency cash reserves. Many business owners, professionals, and others with relatively abundant assets are taking a more conservative approach to their personal “rainy day” funds, which are typically used to supplement any loss or disruption in a personal income stream or to take advantage of unexpected business or professional opportunities.
Most people are familiar with the rule of thumb to have on hand six months’ living expenses. But even among wealthy people, it’s very rare in my experience to see that level of reserves actually held in cash in bank accounts. In most cases, individuals prefer to have excess cash invested rather than in lower-rate bank savings or money-market accounts.
Often, people identify their taxable investment accounts as a secondary source of cash for unexpected needs or opportunities. They figure they can sell positions in their account to quickly raise cash if needed. But what if that cash need comes at an inopportune time to sell?
To avoid the need to sell (and possibly create a taxable event) consider a line of credit with securities in a nonqualified investment account as the collateral. These “securities-backed lines of credit” (SBLOCs) allow borrowers to “stay invested” — including maintaining trading ability — even while drawing on the line. Furthermore, the access to cash is truly immediate, as there’s no need to wait for trade settlement.
Recently, I was meeting with a private banking client of mine who was signing documents for a new line of credit. He said, “I can’t believe we didn’t take advantage of this sooner. In the past, we’ve had to sell from our investment account as we’ve had needs for additional cash, and we’ve been missing out on the future returns from those funds we liquidated.”
Securities-backed line of credit vs. home equity line of credit
A securities-backed line of credit has much in common with the more familiar home equity line of credit (HELOC). Both can be used for almost any purpose. Among the more common uses are living expenses (in the event of income interruption), business interests, real estate investments or home renovations, and college expenses.
Like a HELOC, an SBLOC gives people the option to borrow only as needed. Both provide flexible monthly repayment terms and low, competitive interest rates.
In years past, HELOCs had an advantage in the form of favorable tax treatment, since borrowers could deduct interest payments from their income taxes in like manner as interest on primary mortgages. However, HELOCs lost that advantage (with some exceptions) in the 2017 tax reform. Now the two types of credit lines are on a more level playing field.
I’ve seen that some individuals are averse to HELOCs on an emotional level. When people have worked over many years to pay off a mortgage debt, they may not want to introduce another mortgage. In my experience, people are more comfortable pledging their securities as collateral than adding a lien on their home.
Note that with both SBLOCs and HELOCs, there is a risk of needing to pay down borrowed principal in the event of a severe market decline, as happened with both securities and home values during the Great Recession of 2008.
The following table provides an overview of HELOCs and SBLOCs together with a third type of credit line commonly used for emergency cash purposes — an unsecured line of credit.
Many individuals are generally familiar with unsecured lines and HELOCs — but keep a securities-backed line of credit in mind. It might be the best solution available, to not only provide access to immediate cash but also to keep you on track to meet your retirement goals.
As with any financial decision, deciding which — if any — of these is appropriate to meet your current and future needs is a process of evaluating the size of the need, your risk tolerance, and other individual factors. It’s important to discuss these options with your banker and come up with the solution that will be most beneficial to you.
Ron Jahnke is vice president – private banking officer at Waukesha State Bank. Contact him at firstname.lastname@example.org or (262) 522-7405.
*Not FDIC Insured *Not Guaranteed by the Bank *Not a Deposit *May Go Down in Value *Not Insured by Any Federal Government Agency
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