Stock-Based Loan Programs: What Investors Need to Know
The Financial Industry Regulatory Authority (FINRA) published an Investor Alert on the risks and rewards of non-recourse stock-based loans, loans which are given to borrowers who pledge fully paid securities as collateral to the lenders. This collateral is the only recourse the lenders have with which to reclaim the loans from the borrowers. The lender holds the securities during the period of the loan and returns them – with profits – at the end of the loan.
Investors should be aware of the risks associated with stock-based loans. Firstly, the interest rates are relatively high and so investors seeking to profit by being a borrower of the stock-based loan will only profit if the collateral security appreciates more than the loan plus interest. Secondly, there is a risk that the lender does not return the collateral to the investor at the end of the loan. Thirdly, an investor, without cash or other liquid investments at hand, should not invest the proceeds of the stock-based loan in long-term instruments, since the stock-based loan is usually short-term and so by the time the loan ends the investor must have cash or liquid investments ready at hand to pay back the loan. Other risks include tax risk (being taxed on the proceeds of the loan or the collateral security when you would otherwise not have to pay such taxes) or having your lender immediately selling your collateral security immediately after the loan takes place (and therefore you are robbed of any appreciation the security might experience during the term of the loan).
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