Let's say you want to take out a loan to buy a new car. Unless you are willing to make a substantial down payment, the car is going to be worth less than you owe on it the minute you drive it off the lot. Even if the loan is secured by the car, your lender knows it is not fully secured, so he jacks up the interest rate to help offset his risk. You can usually get a better interest rate by taking out a loan with your bank or investments broker and putting up your stocks as collateral.
Stock Secured Loan
A stock secured loan is a loan made by a financial institution that is secured by your stock. Financial institutions, such as banks, mortgage companies, credit unions and savings institutions make stock loans. You typically need an account with the institution before you can apply for a stock loan. The maximum you can borrow against your stock will vary by institution, but is typically between 50 and 80 percent of the market value of the stock. The lending institution will hold your stock during the period of the loan, but you are entitled to any dividend payments. The financial institution may take possession of your stock if you default on your loan.
A classic way to borrow against your stocks is to open a margin account with your investments broker. A margin account allows you to buy additional stock or other securities on credit, using the stock in your account as collateral. Margin accounts are regulated by the Securities and Exchange Commission. The SEC requires investors to establish an initial margin of no more than 50 percent. That means you can buy twice as much stock as you could with a cash account for the same initial investment.
You can use borrowed money from your margin account for more than just buying securities. For example, you can deposit stock into your margin account and borrow 50 percent of the value of the stock in cash. Use the cash to buy a car, go on vacation or for just about anything else that strikes your fancy. Interest rates on margin accounts are typically lower than those on unsecured loans from other financial institutions.
Borrowing against your stocks comes at a price. Stock-secured loans and margin accounts may charge interest at a rate that is lower than prevailing rates, but they still charge interest. If the value of your stock dips below minimum levels, typically 25 percent of the initial value, your broker may issue a margin call. You must immediately deposit enough cash or additional securities into your account to bring it back up above prescribed levels. If you don't, your broker has the right to sell your stocks at the market price to make up the difference.