Non-Purpose Loan
Loans made by a broker or dealer against the securities in an investor's account that are not for any specific purpose.
What Is a Non-Purpose Loan?
Non-purpose loans are non-traditional loan types where investment securities are held as collateral. These loans are made by a broker or dealer against the securities in an investor's account that are not for any specific purpose.
It's a loan where the security serving as collateral is purchasing something other than additional securities.
A line of credit known as a "non-purpose loan" enables borrowers to use the funds for personal expenses while putting up assets as security.
It is prohibited to use them to buy, hold, or trade securities such as stocks or bonds.
It may be preferred over a typical installment loan due to its lower interest rate. The exact margin requirements that apply to loans with a margin do not apply to loans without a specific purpose.
For purposes other than making new investment purchases, a borrower may use the value of their current securities, such as stocks or mutual funds, as collateral for the loan.
Key Takeaways
- A Non-Purpose Loan, also known as a non-purpose credit or non-purpose financing, is a type of loan made by a broker or dealer against the securities in an investor's account, and it is not designated for any specific purpose.
- Non-purpose loans provide a line of credit that allows borrowers to utilize the funds for personal expenses while using their assets, such as stocks or mutual funds, as collateral.
- One notable feature of non-purpose loans is the potential for lower interest rates compared to typical installment loans.
- A purpose loan is specifically extended for a defined use, such as purchasing real estate, while a non-purpose loan has no specific use restrictions, allowing borrowers to spend the funds on various activities.
Definition and Examples of a Non-Purpose Loan
An unconventional loan type that uses an investment portfolio as collateral. The structuring is intricate, and the money raised cannot be used to buy or sell securities.
It is available from financial institutions and brokerages with government-regulated documentation requirements. Borrowers may use this loan to pay for home purchases and educational costs.
An example is a securities-backed line of credit or SBLOC. The collateral for an SBLOC can be eligible securities from the investor's investment portfolio.
With the exception of purchasing or carrying margin stock, the investor is free to use the SBLOC for a wide range of activities.
Brokerage firms may offer investors SBLOCs. Borrowers may be subject to risky terms and conditions with these loans.
For example, lenders of securities-based loans might demand that borrowers meet and maintain certain collateral requirements. If the value of the pledged collateral falls, borrowers may be required to deposit more money or certain securities.
An additional example is the Collateral Lending Program at TD Ameritrade. Investors with TD Ameritrade securities holdings have the option to borrow money from their accounts to pay for a variety of expenses.
How Does a Non-Purpose Loan Work?
The loan operates in a certain way. A lender extends credit to borrowers in exchange for securities used as security. Owners of stocks, for instance, may use such securities as collateral for the loan.
It might be available to an investor who already has investments in the form of securities in their account. Because of this, the investor would be able to maintain their current investment portfolio while continuing to accrue returns and dividends.
Even though an investor in the United States may be able to borrow up to 70% of their diversified investment portfolio, the exact amount will depend on the lender's requirements.
Investors who guarantee these loans are required to keep the securities that guarantee the loan in a separate cash account until the loan is completely paid off.
If the value of the account containing the securities serving as collateral falls below the threshold necessary for the securities to guarantee the loan, the investor may become subject to maintenance calls.
These calls inform the investor that, within a predetermined amount of time, they must either contribute additional funds or repay the loan. If the investor does not comply with either of these requirements, the securities may be sold.
Pros of a Non-Purpose Loan
The following is a list of some of the benefits associated with this loan:
- Flexibility: Borrowers who take out non-purpose loans have the flexibility to spend money on almost anything, as long as it is not used for buying or carrying margin stock.
- The non-purpose credit can be used to finance a dream vacation or home repairs, among other things, and borrowers can get approved relatively quickly.
- Interest: It typically has a low-interest rate for borrowers to take advantage of. The borrower could receive financing worth hundreds of thousands of dollars or even millions of dollars through these loans, and the borrower might not have to pay any closing costs.
- Securities as Collateral: A well-diversified investment portfolio enables investors to use eligible securities as collateral for sizable loans. This can give investors quick access to capital without liquidating their securities holdings.
- Rapid approval procedure: When compared to the documentation demands of traditional lending products, the requirements for getting approved for this type of loan are typically less stringent.
Cons of a Non-Purpose Loan
To avoid any unexpected situations, it is crucial to weigh the need for financing and comprehend the risk of losing the investment portfolio over non-payment prior to signing for a non-purpose loan.
There are a few other drawbacks associated with such loans that must be taken into consideration, despite the benefits that they offer. We list a few drawbacks below:
- Volatility: Borrowers could be negatively affected by volatility in the equity markets. The value of the stocks and other securities that make up your investment portfolio is subject to market fluctuations. If the value of your pledged collateral declines, lenders may require you to deposit additional funds or qualified securities.
- Limited Funds: Borrowers who take out such loans are not permitted to use the money to purchase, hold, or trade additional securities. If you need to borrow money to buy stocks or bonds, you might need to look into other options.
- Issues with Liquidation: If the market value of the securities declines below a specific threshold, then certain contracts may also cause the liquidation of the borrower's portfolio. Borrowers must weigh the risk of losing their investment portfolio before accepting such a loan.
Purpose vs. Non-purpose Loan
An extension of credit made to purchase or carry margin stock is a purpose loan. According to federal regulators, a margin stock can be either equity or debt securities or securities issued by an investment company.
A credit line extended for a purpose other than purchasing or carrying margin stock is known as a non-purpose loan.
While purpose loans may be unsecured and without collateral, non-purpose loans are secured by margin stock.
A purpose loan is restricted to a specific use (such as the purchase of real estate or construction projects), and the bank will look into this use before approving the loan (the client must submit, for example, a purchase contract).
Any purpose (including a vacation) is acceptable for a non-purpose loan, meaning the bank is not required to look into the borrower's intended use.
Loans with specific purposes and those without specific purposes are not always superior. The borrower may be at risk with either choice.
An unsecured purpose loan may be preferred over non-purpose loans by investors who cannot bear the risk of pledging securities as collateral.
Non-purpose loans may be more appealing to other investors who want quick access to capital without having to sell their holdings in securities.
Alternatives to a Non-Purpose Loan
Non-purpose loans give investors access to cash while preserving the balances in their investment accounts. Investors can apply for it by pledging the value of their securities as collateral.
Let's discuss some of the alternatives.
Secured Loan
A secured loan is one in which the borrower pledges an asset as security for the loan, turning the pledged asset into a secured debt owed to the lender (the creditor).
Borrowers also have the option of securing their loans in other ways, such as through mortgages on their homes which would be secured by the value of the house used to purchase the property.
Unsecured Loans
An unsecured loan, such as a personal loan, does not require collateral to ensure the lender will be paid and can be obtained by the borrower.
Personal loans can be a good substitute. Depending on their needs, consumers may take into account one of at least 12 different types of personal loans.
The use of credit cards can replace unsecured loans. Each credit card account has a predetermined credit limit that sets a limit on the amount you can charge.
Cardholders can make monthly payments that equal or exceed the minimum payment required and are expected to pay off their credit card debt over time.
More rigorous qualification standards, such as a thorough evaluation of credit and income to determine the likelihood that a borrower will repay the debt, are frequently applied to loans that are not backed by securities.
These might have a higher interest rate than loans without a specific purpose.
Researched and authored by Shriya Chapagain | LinkedIn
Free Resources
To continue learning and advancing your career, check out these additional helpful WSO resources:
or Want to Sign up with your social account?