What are the Risks of Stock-Secured Loans?

Secured loans are extended based on the value of collateral posted with the lender. In some cases, this collateral is a home or automobile. With stock-secured loans, the original stock certificate of the stock you are collateralizing is placed with the bank as collateral. Secured loans are usually cheaper than unsecured loans because the borrower assumes the risk. There are many risks involved with securing a loan against stock. 

Assessed Value of Stock

One factor that comes into play is the value of the stock being collateralized. Depending on the market, the value of the stock will fluctuate. In a recession, a borrower will get a "bad deal" on the loan because the stock will not be valued very high. If the value of the stock goes up during the life of the loan, the terms of the loan do not change. That means the borrower could end up with collateral worth $3,000 against a loan for $500. Defaulting on that loan would be a two-fold loss to the borrower. 

Loan to Value Ratio

Banks and lenders use a loan-to-value (LtoV) ratio to determine the limits on all collateralized loans, including stock loans. Real estate loans and auto loans use an LtoV, and the particularly LtoV the bank is offering will depend on the asset being placed as collateral. Most banks and lenders offer a portion of the total value of the asset, typically between 50 and 75% on a stock loan. If the LtoV is too low, the borrower is assuming a greater risk. A default on the loan could mean that the borrower is out much more than the amount they borrowed in the first place when the stock is forfeited. 

Loss of Asset

The biggest risk with any secured loan is the loss of the asset in the case of a default. Today, many Americans have their retirement funds and college funds tied to the value of their stock portfolios. Leveraging a portion of this portfolio in order to secure a loan is placing those savings at risk. Secured loans should only be pursued by those individuals who have the resources to continue to make loan payments even if there is a fiscal emergency such as a job loss or medical emergency. 

Affect on Credit Score

A borrower's credit score is most important when the borrower is seeking expensive loans, such as a mortgage or auto loan. If you are going to be seeking one of these loans soon, it is important to keep your debt load small and build your credit score. Leveraging some of your assets through a stock loan can drop your credit score temporarily. When a secured loan is paid off, it does have a positive effect on a credit score, but not to the same degree as when an unsecured loan is paid off. 

 


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