Investment Line of Credit - a clever way to finance buying real estate

[Daisy]

As a FIREd person looking into buying a house, I was trying to get a mortgage in order to keep my money invested in the market. I was able to get an offer on a decent mortgage after running through a lot of hoops. Then I called my locally owned bank with whom I have banked with for years and, in addition into looking for a mortgage for me, they offered me an investment line of credit when they found out about my invested assets. I thought it was a great idea and that is the route I chose to finance my new home. I could have sold assets to buy the house in cash, but in this case I am leveraged and remain invested in the stock market.

It's is kind of like a home equity line of credit, but the collateral is your investment account. I can use it for whatever I want.

So, I open up the line of credit can can then purchase the house in "cash", thereby simplifying the home purchase process a lot. They don't require me to get home insurance or anything.

They are offering me 0.5 points off the prime rate. The current prime rate is 3.25% so the loan is at 2.75%. Of course, this is not a fixed rate. It is tied to the prime rate, so I am running interest rate risk but I can always switch to a traditional 30 year mortgage whenever I want if I see interest rates are going to go higher.

I can have access to 70% of my invested funds. I was forced to put some investment assets with the local bank's brokerage arm in order to get the good rate. They could offer me the loan with an external brokerage, but they would charge a slightly higher interest rate. Since I still had some stocks and funds from the past, before I learned about the wonders of Vanguard, I moved those assets over as I was already paying a management fee.

I don't think Vanguard offers this product, although I saw a news headline recently that they are looking into it.

I thought I would share this idea with other FIREd people. It's also a good idea if you want to get rental properties.

[crimp]

If there's a flash crash of 20-30% in the market, are you at risk of margin calls? Can they liquidate your investments in that instance?

[Daisy]

If there's a flash crash of 20-30% in the market, are you at risk of margin calls? Can they liquidate your investments in that instance?

That is a good question that I had been wondering about. The line of credit is only open to 70% of my invested assets with them, so I assume they take that into account. I know they could lend me up to 80% with a different mix of assets. I am actually signing off on the loan next week and will ask.

At this point, I am only going to draw on 65% of the amount, so I feel pretty safe.

[Proud Foot]

The most recent blog post talks about this.

https://www.mrmoneymustache.com/2021/01/29/margin-loan-ibkr-review/

[Daisy]

The most recent blog post talks about this.

https://www.mrmoneymustache.com/2021/01/29/margin-loan-ibkr-review/

Wow! What a coincidence. MMM and I were learning about these loans at the same time.

I credit MMM for giving me the idea to get a home equity line of credit in the past to buy another house. But this time, we both did this together (but separately ;-) ).

I did look up margin lines of credit after learning about this, but I thought it was only to buy stock with.

In the loan offered to me, I can do anything I want with it. And as my investments grow, I will have more I can draw from.

They were going to structure it as a fixed payment paying down principal and interest over 30 years, but I told them I preferred an interest only line of credit. I can choose to pay or not pay down principal on my terms, not theirs.

Honestly, as a single person with no dependents, I see no real need to leave anyone anything when I die. I figure I can keep this line of credit open and only pay interest (as long as it continues to make sense). If I die tomorrow, my siblings can just sell my investment assets to pay off the line of credit.

I do have most of my funds in Vanguard. If they offer a similar product in the future, I may just open a line of credit with them and just use it for an impulse purchase like MMM did.

I think some other banks use the term "asset backed loan" for this type of product.

I can tell you after handling my elderly father's finances, you don't want to get older with rising health costs and be house rich (mortgage paid off) and cash poor. And when you are older, no one is going to give you a home equity line of credit. We tried with him and he could only borrow a little.

This approach seems to solve those problems.

[Daisy]

Oh, another thing, I don't think the interest is tax deductible. But with the high standard deduction these days, who cares!

[MustacheAndaHalf]

In the loan offered to me, I can do anything I want with it. And as my investments grow, I will have more I can draw from.
...
I do have most of my funds in Vanguard. If they offer a similar product in the future, I may just open a line of credit with them and just use it for an impulse purchase like MMM did.

A word of caution that investments can drop rapidly, like last year.  Margin loans are backed by your investments, so if your investments shrink while your loan stays the same, IBKR can sell your investments to pay down the loan.  You do not have a choice on the sale, or what investments of yours get sold.  Vanguard is nicer, giving a margin call that requires depositing more cash or selling investments, but their margin loan rate is close to 8%
https://investor.vanguard.com/investing/margin

If your margin loan is 1/5th of your account balance, it's very different than being over half your account balance.  I think MM did it short term and with a small percentage, which is a safer approach.

[Daisy]

My loan was not called a margin loan by the bank. The official term they are using is investment line of credit . But I will ask on Monday when I sign the papers. This is also a very conservative local bank and they know me personally so I don't think they would do anything crazy. But I will ask what happens in a market downturn.

Good points being brought up as usual from this MMM crowd. You're the best!

[Daisy]

So I have been dealing with their banking function and brokerage function, both parts of the local bank. Now I remember that when I opened the brokerage account with them they did open it as a non-margin account. So I am interested to see what their answers are on Monday when I ask about market downturns.

The loan is a consumer loan being offered by the bank. I did have to pay the customary $1000 in documentation stamps to the state for opening a new loan. That was really the only cost. A one-time thing. I can draw on the line of credit whenever I want after that.

So I guess it is a different financial product than what MMM got.

Any other questions that I should ask the banker on Monday?

[MustacheAndaHalf]

My loan was not called a margin loan by the bank. The official term they are using is investment line of credit . But I will ask on Monday when I sign the papers.

Oh, I was talking about what IBKR and Vanguard offer, rather than a bank loan.

You could ask under what conditions they can freeze or close the line of credit, since I think the answer is for any reason they want at any time.

It's worth knowing their current interest rates on this line of credit.

[Gin1984]

So I have been dealing with their banking function and brokerage function, both parts of the local bank. Now I remember that when I opened the brokerage account with them they did open it as a non-margin account. So I am interested to see what their answers are on Monday when I ask about market downturns.

The loan is a consumer loan being offered by the bank. I did have to pay the customary $1000 in documentation stamps to the state for opening a new loan. That was really the only cost. A one-time thing. I can draw on the line of credit whenever I want after that.

So I guess it is a different financial product than what MMM got.

Any other questions that I should ask the banker on Monday?

Do you telling us what bank this is?

[celerystalks]

Not sure about this one. In my opinion it is usually best to use a low volatility asset for loan collateral.  It leads to the fewest surprises later on. When borrowing money the goal should not be reducing the hassle but instead stress testing the decision under terrible depression-like conditions. This is the function of loan underwriting. If the bank is giving an individual a hard time over the financing of a house with a traditional financing option but happily facilitates a loan against an investment portfolio, one should stop and think.

My recommendation would be to lock in an historically low interest rate now using a traditional mortgage loan instead of hoping prime stays low, the investment portfolio stays stable, and/or that you can still qualify for a 30 year fixed rate mortgage later on if economic winds shift.

[secondcor521]

Any other questions that I should ask the banker on Monday?

For completeness, I'd think you'd want to know how often the rate adjusts.  It used to be that for regular adjustable rate mortgages, they'd adjust once a year, but your loan product might differ.

Personally I wouldn't do this, because of the unknown aspects of potential margin calls and the variable rate.  We're at among the lowest rates in a very long time; I'd lock those in.  Especially if I planned to be in the house for a long while (which most of the time we do).

[terran]

It seems like this could be a good way to able to make a "cash" offer or maybe in lieu of a construction loan if you were building or doing a major remodel on a house that wouldn't currently qualify for a conventional loan, but I'd agree with the others that I'd get a conventional fixed rate mortgage as soon as you're eligible.

[Daisy]

I just returned from signing the loan papers so I will answer some questions.

[Daisy]

You could ask under what conditions they can freeze or close the line of credit, since I think the answer is for any reason they want at any time.

I asked and they said, of course, if there are some major market disruptions all loans/lines of credit are written to include this language. However, let's say I have access to $300k line of credit, if I have used $200k of it, they will not ask me to pay that immediately, but may freeze accessing more.

For example, during the 2008 financial crisis some home equity lines of credit were frozen in a similar manner.

This is a very conservative local bank, so I don't think they would offer lines of credit to people that don't have significant assets.

This is one of the oldest, if not oldest, independent local banks in South Florida that has resisted the urge to merge with the big banks. They are very well known and respected in the area. They were recommended by a banker friend of mine that knows the business. They don't even offer residential home loans as they are too risky for them.

It's worth knowing their current interest rates on this line of credit.

If you open a brokerage account with them they are offering prime rate - 0.5. With an external brokerage it is prime rate +0.5.

Current prime rate is at 3.25% so my rate is at 2.75%.

[Daisy]

Do you telling us what bank this is?

I don't want to post this on a public forum, but if you PM me I can give you the information.

It is an independent local bank in South Florida.

I asked and they said they can offer it to anyone, regardless of where they live.

I also asked if my FI friends can call him and he seemed happy for the business.

[Daisy]

Not sure about this one. In my opinion it is usually best to use a low volatility asset for loan collateral.  It leads to the fewest surprises later on. When borrowing money the goal should not be reducing the hassle but instead stress testing the decision under terrible depression-like conditions. This is the function of loan underwriting. If the bank is giving an individual a hard time over the financing of a house with a traditional financing option but happily facilitates a loan against an investment portfolio, one should stop and think.

They are managing your portfolio, so they are comfortable with this risk.

I initially thought of moving VTI to their brokerage and they were fine with that since it is stable. However, i didn't want to pay someone management fees to hold VTI for me. So I moved some other older assets I had that I was already paying management fees for. We will then rebalance their portfolio to meet their risk profile.

My recommendation would be to lock in an historically low interest rate now using a traditional mortgage loan instead of hoping prime stays low, the investment portfolio stays stable, and/or that you can still qualify for a 30 year fixed rate mortgage later on if economic winds shift.

I looked into 30 year mortgages too, but as a recently FIREd person you have to run through a lot of hoops and show 3 years of stable/same income streams. One bank did give me a quote, another one was uncomfortable with only showing 2 years of this strategy.

I can always get a mortgage in one or two years if I see signs the prime rate is going to start to rise.

I am also saving money by not having to buy home insurance if I don't want to, which in South Florida is a sizable amount of money each year.

I am buying a house from a trusted neighbor, so I opted not to pay for an appraisal or inspection either.

[Daisy]

For completeness, I'd think you'd want to know how often the rate adjusts.  It used to be that for regular adjustable rate mortgages, they'd adjust once a year, but your loan product might differ.

Personally I wouldn't do this, because of the unknown aspects of potential margin calls and the variable rate.  We're at among the lowest rates in a very long time; I'd lock those in.  Especially if I planned to be in the house for a long while (which most of the time we do).

It's based on the prime rate determined by the Federal Reserve, which doesn't change that often or too abruptly. But yes, I will keep an eye on it and convert to a fixed rate mortgage if I see dangers ahead.

They have a personal relationship with you, so they told me they would not sell right away. I may have to put more cash in to stay at 70% if there is a downturn, but they would check with me first.

They looked at all of my other assets to know that I am not fully leveraged and have the means to pay in a situation like this.

They also said they wouldn't require it if I am within 5% of the allowable LOC.

I am not taking out the full 70% so there is wiggle room for a downturn.

[Daisy]

It seems like this could be a good way to able to make a "cash" offer or maybe in lieu of a construction loan if you were building or doing a major remodel on a house that wouldn't currently qualify for a conventional loan, but I'd agree with the others that I'd get a conventional fixed rate mortgage as soon as you're eligible.

Yes! Great way to make a cash offer.

And as MMM says in his post, in this highly competitive real estate market it may be the edge you need to get the house you want.

I can use the LOC for anything except buying stocks on margin (I asked).

[Dicey]

...I can tell you after handling my elderly father's finances, you don't want to get older with rising health costs and be house rich (mortgage paid off) and cash poor. And when you are older, no one is going to give you a home equity line of credit. We tried with him and he could only borrow a little.

In my city, more than 25% of the population is over 65. I hear this sad story all the damn time.  A friend's husband is making an absolute killing because he's in the Reverse Mortgage business.

This is the very reason I continue to mostly ignore the mortgage payoff races and champion the DPOYM thread. By the time the "First, Kill ALL the Debt" crowd realize this important lesson, it will probably be too late.

. 

[Daisy]

...I can tell you after handling my elderly father's finances, you don't want to get older with rising health costs and be house rich (mortgage paid off) and cash poor. And when you are older, no one is going to give you a home equity line of credit. We tried with him and he could only borrow a little.

In my city, more than 25% of the population is over 65. I hear this sad story all the damn time.  A friend's husband is making an absolute killing because he's in the Reverse Mortgage business.

This is the very reason I continue to mostly ignore the mortgage payoff races and champion the DPOYM thread. By the time the "First, Kill ALL the Debt" crowd realize this important lesson, it will probably be too late.

.

Yes, I used to own a condo all paid with no mortgage until I learned about this.

I then moved in to my parents house and sold the condo in order to help them out with daily stuff. Unfortunately they just passed away within 5 months of each other and I am now moving on, wiser from the experience.

I WILL finance to buy a house, even though I can buy one in cash.

I will try to get and keep debt and get it while I am young enough to do it. I can have this LOC open until the day I die, I hope. My siblings can pay it off when I pass away.

And I don't mind keep this debt open, only pay interest (as long as interest rates stay low) if my money can grow more in the market.

I won't get a margin loan (don't think), but if Vanguard offers these type of LOC in the future I might open one up with them too!

[Dicey]

Ooh, Daisy, I didn't realize that. I am so sorry for your loss.

[chasesfish]

As others have said, just make sure you have a clear understanding of the maintenance requirement.

Usually margin calls happen when you go above 75% on equities and 90%+ on certain bonds.

Many wealthy people use these products, they tend to borrow against their treasury bond allocation because of the higher advance rates and lower volatility.

I'd love to do this to buy my house, but 75% of my assets are in qualified accounts and not eligible as collateral

[Daisy]

Ooh, Daisy, I didn't realize that. I am so sorry for your loss.

Thank you! It was very rewarding to spend the last couple of years when my parents needed me most...one of the blessings of being FIREd!

From reading your posts, I know you are dealing with an elderly parent too. Although I don't read journals so I hope everything is going well for you.

[Daisy]

As others have said, just make sure you have a clear understanding of the maintenance requirement.

Usually margin calls happen when you go above 75% on equities and 90%+ on certain bonds.

Many wealthy people use these products, they tend to borrow against their treasury bond allocation because of the higher advance rates and lower volatility.

I'd love to do this to buy my house, but 75% of my assets are in qualified accounts and not eligible as collateral

Yeah I am starting to realize the bank offered me this after explaining my situation to them. I told them I had other FI friends that might want to take a look at it.

It looks like rich people have been doing this for a long time, but I just learned about it!

When you have built up significant assets, everyone wants to do business with you!

[Sibley]

I understand that home insurance isn't required, but make sure you think the pros and cons through of it. Especially since you could get bulldozed by a hurricane.

[chasesfish]

@Daisy - One of my former clients would park his low volatility portfolio with us then we made a line of credit to his LLC.  That LLC turned around and made syndicated real estate investments and he basically borrowed at 3% and made 9-13%.

It's nice to have capital

[Daisy]

I understand that home insurance isn't required, but make sure you think the pros and cons through of it. Especially since you could get bulldozed by a hurricane.

As a native Floridian, I know these risks. A house with hurricane impact windows and a new roof mitigates some of those risks. I also know how insurance companies behave in these circumstances.

So I am not opposed to it, and will look into it after I move in and assess the costs. Luckily I have the freedom to choose what I want to get.

[Daisy]

@Daisy - One of my former clients would park his low volatility portfolio with us then we made a line of credit to his LLC.  That LLC turned around and made syndicated real estate investments and he basically borrowed at 3% and made 9-13%.

It's nice to have capital

Yes! And his investments kept growing in the market in the meantime.

This opens up many opportunities. Thanks for the feedback.

[robartsd]

I wonder if you could purchase a house using an investment entity you fully own to secure a good deal, then shop for a regular mortgage to purchase the house for yourself personally from your investment entity? I'm basically thinking you could do what MMM is doing for his friend, but for yourself. Could you shop with all the advantages of a cash offer, but still ultimately lock in a fixed rate mortgage used for the purchase of a primary residence?

[Daisy]

I wonder if you could purchase a house using an investment entity you fully own to secure a good deal, then shop for a regular mortgage to purchase the house for yourself personally from your investment entity? I'm basically thinking you could do what MMM is doing for his friend, but for yourself. Could you shop with all the advantages of a cash offer, but still ultimately lock in a fixed rate mortgage used for the purchase of a primary residence?

That is my plan. Because at some point the prime rate is going to go higher. Although the Federal Reserve is saying they will keep the prime rate at its current rate until 2023. By that time I'll have a couple of more years to show stable income for a regular mortgage.

[celerystalks]

I can tell you after handling my elderly father's finances, you don't want to get older with rising health costs and be house rich (mortgage paid off) and cash poor. And when you are older, no one is going to give you a home equity line of credit. We tried with him and he could only borrow a little.

Just thought I’d point out that your plan doesn’t really align with this goal, though. By using investments as collateral to buy the house outright,  this is the equivalent of having a paid off mortgage. And if this is combined with a bout of volatility and an unexpected selling out of the investments at the worst time by the creditor, this could result in leaving you house rich and cash poor.

[Daisy]

I can tell you after handling my elderly father's finances, you don't want to get older with rising health costs and be house rich (mortgage paid off) and cash poor. And when you are older, no one is going to give you a home equity line of credit. We tried with him and he could only borrow a little.

Just thought I’d point out that your plan doesn’t really align with this goal, though. By using investments as collateral to buy the house outright,  this is the equivalent of having a paid off mortgage. And if this is combined with a bout of volatility and an unexpected selling out of the investments at the worst time by the creditor, this could result in leaving you house rich and cash poor.

Good point. Well, I do plan to convert to a mortgage at some point.

But even with getting a mortgage, by the time I get to my father's age the mortgage might be paid off.

My main point with this is having access to lines of credit.

My father could only get a home equity line of credit for around $100,000 in his late 80s on a house worth $600,000+, with excellent credit history.

If I can keep refinancing to have a mortgage in my mid-80s that would be awesome!

With my current line of credit, I don't have to pay it down. The ideal thing is to die with this LOC open and my heirs will then pay it off by selling securities. That is most likely what they will do with my assets, as we did with my father's assets, as you inherit them at the cost basis of the person's death. So they will pay no tax on those gains and then can pay off the LOC and divvy up the rest.

BTW, I like these comments as it helps me refine my plans.

[robartsd]

It makes sense that a brokerage account LOC would allow a higher loan to value ratio than an home equity LOC. The brokerage account has direct access to highly liquid assets as collateral, the home equity LOC has to foreclose on, then sell a single high transaction cost asset that may be in a significantly poorer condition than it was when the LOC was opened.

All this is pretty much theoretical to me, I have enough tax advantaged space, that I may never have significant taxable investment accounts.

[ChpBstrd]

If there's a flash crash of 20-30% in the market, are you at risk of margin calls? Can they liquidate your investments in that instance?

This is the #1 risk. Getting liquidated in late March 2020, for example, and taking 2-3 months to get another mortgage in place so that you can get back into the market would be a sequence of returns risk event.

The #2 risk is that interest rates increase by, let's say, 3%. This would hit you twice because your adjustable rate mortgage payment would go up, and because the value of the property would go down.

To mitigate #1, ask if you can put more than the bare minimum of your assets under the bank's management, so that a margin call is less likely. To mitigate #2, you could get into interest rate swaps or maintain a put option position on TLT, but these solutions might cost more than mortgage closing costs.

[Daisy]

If there's a flash crash of 20-30% in the market, are you at risk of margin calls? Can they liquidate your investments in that instance?

This is the #1 risk. Getting liquidated in late March 2020, for example, and taking 2-3 months to get another mortgage in place so that you can get back into the market would be a sequence of returns risk event.

The #2 risk is that interest rates increase by, let's say, 3%. This would hit you twice because your adjustable rate mortgage payment would go up, and because the value of the property would go down.

To mitigate #1, ask if you can put more than the bare minimum of your assets under the bank's management, so that a margin call is less likely. To mitigate #2, you could get into interest rate swaps or maintain a put option position on TLT, but these solutions might cost more than mortgage closing costs.

I've already mentioned that the bank will contact me first before doing anything. I can put more cash, or for that matter, some VTI from my Vanguard account temporarily with the bank to stay at 70%.

Yes, I am monitoring prime rate hikes. The Federal Reserve's latest statement implies they will remain with low interest rates at least until 2023. And once they start rising, they will do it slowly.

[jeromedawg]

What are the major differences and pros/cons of going this route vs doing a delayed finance loan?

[Daisy]

What are the major differences and pros/cons of going this route vs doing a delayed finance loan?

I don't know what a delayed finance loan is.