What Is Securities-Based Lending?

Full quote provided:

“1) It can be more difficult to obtain a securities-backed loan (SBL) than an ordinary home mortgage. Basic mortgages are often securitized and traded in secondary markets, which makes banks eager to originate them. An SBL involves a closer relationship with the financial institution sponsoring it.

Securities-backed loans are often based on a floating interest rate that could move from month-to-month. In contrast, most mortgages lock in at a fixed interest rate.

2) If the SBL borrower manages to pay back the loan, they continue to retain their collateralized securities in addition to any property they purchased with the loan. At the end of a home mortgage, the borrower only retains the property they purchased.

If the loan amount is large enough, the interest rate spread on an SBL can be much tighter than an ordinary mortgage. However, because the rate is floating it may exceed a fixed-rate mortgage over the long-term.

3) Securities-backed loans have a significant market risk. With a home mortgage, the lender would only foreclose if payments are missed. But with an SBL, the lender may liquidate the securities if they lose value in excess of the remaining principal balance.

If interest rates rise, the borrower of an SBL could find themselves owing more in monthly interest than fits their budget.

4) The market for SBLs is less developed than home mortgages. It may be difficult to find a financial institution to provide the loan.

Not all securities are collaterizable at the same rate. Lenders dictate the amount that can be borrowed against each security. However, it is in the interest of both parties that the value of the securities remains stable so the lender doesn’t have to liquidate them.

5) Consider future changes to short-term interest rates. Don’t overleverage. Have a plan to handle market volatility.”