Securities-Backed Loans And Divorce

An innovative form of lending and financing is available to more affluent investors, and it can cause some confusion in the distribution of assets phase of divorce. Many large brokerage firms, and some independent banks, offer clients what are known as “Securities-backed Loans,” which are essentially interest-only lines of credit that may be used for a variety of purposes, such as buying a vacation property or helping to finance college, and which are secured by an investment portfolio. As practically important as they are, there are some important considerations and challenges with Securities-backed Loans and divorce.

Assuming that an investor can qualify for the loan (yes, there is a credit check and financial information needed, though it is by no means as paper-intensive as a mortgage), they may establish what is known as a “pledge account” into which a portfolio of non-retirement investments can be transferred. Be aware that most firms will allow only very liquid and marketable investments to be pledged (diversified common stocks, mutual funds, corporate or government bonds, etc.), and generally will not lend against a single stock position. Once the investments are in the pledged account, the firm is able to lend at their stated interest rate, which is generally comparable to mortgage rates.

So how do these loans complicate the division of assets process? Let’s take a look at a real-world example. Jim and Nancy pledged $1 million of their investments at a major brokerage firm to establish a line of credit of $600,000. They used that line of credit to purchase a beautiful vacation property in Virginia. Their goal was to vacation there in the Summer with immediate and extended family for years to come. Unfortunately, divorce intervened.

As Jim and Nancy, and their lawyers contemplated dividing the assets in their marital estate, they determined that Jim would take sole ownership of the home, valued at $600,000, and Nancy would receive $600,000 of their non-retirement investments. They would divide the remainder of all of their assets 50/50. Sounds simple and easy, right? Well it wasn’t simply and easily resolved because of the Securities-backed Loan.

A financial planner, who is also a Certified Divorce Financial Analyst, was involved in the analysis of the marital assets, and discovered that in order to maintain the $600,000 line of credit, all $1 million must remain in the pledged account – none of it may be removed, unless it is replaced with cash or more investments. If Jim and Nancy wanted to divide this asset, and Jim wanted to become the sole owner of their vacation property, then he would have to qualify for his own mortgage. His new mortgage on the Virginia property would be utilized to pay back the brokerage firm for their $600,000 loan, and the couple could divide the assets.

In this case, Jim did qualify for a mortgage, and the couple were able to divide their investment account, when the line of credit was repaid. However, in many cases, investors will utilize Securities-backed Loans because the qualification requirements are not as stringent as they would be for a second mortgage. It is often not possible for one party to essentially re-finance the Securities-backed Loan, and the property must be sold, or the loan paid back in some other way, in order to free a significant amount of marital assets. What looked like a simple plan to Jim and Nancy, became a real headache in their divorce. By working with a financial planner experienced in divorce, the couple were able to deal with the issue before signing a property settlement agreement, and then finding an unwelcome surprise.

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Paul T. Murray