Buying real estate often involves applying for a mortgage. This takes time. If you have cash or securities with a financial services firm, you may be able to arrange an asset-based loan in advance. Asset-based loans are not common, but they can give you the ability to act quickly when you find a good deal on a property. There are pros, like the ability to skip the credit check and income verification. There are cons, like putting the asset you are collateralizing at risk.
Typically, people don’t make most big purchases with cash. When buying real estate, they often get a mortgage on the property from the bank. When buying jewelry, they might use a credit card, but the interest rates are high when compared to mortgage rates. Why? Credit card purchases are made with an unsecured line of credit.
There is another way to finance big purchases besides cash and unsecured loans. You can arrange an asset-based loan ahead of time through your financial institution. You pledge certain assets as collateral. These are usually liquid, like money market accounts or securities like stock, bonds, and mutual funds. The bank holds them as collateral. The borrower gets money in return and pays principal and interest payments, similar to a mortgage.
The process has its advantages because it can be fast and doesn’t require the same income or credit checks.
How can asset-based lending help me?
Imagine interest rates are rising and the stock market is volatile. You come across a property owner who needs cash quickly. Several other buyers are interested, but they need mortgages first. That takes time. You walk in and offer to cut a check immediately because you have the advantage of asset-based lending. It puts you in a great negotiating position.
Having an asset to secure a mortgage also makes it easier to qualify for larger loan amounts, which is an advantage as prices, and overall mortgage debt levels, increase.
What is an asset-based mortgage?
How does an asset-based loan work?
When purchasing real estate, banks generally lend with the property as collateral. If the borrower defaults, they foreclose on the property. Banks are in the business of lending money. They will lend against other assets that have a verifiable value. A good example is the stocks and bonds you hold in your investment account. Your financial services firm might have already given you the option to setup the ability to borrow against specific assets. These assets are usually set aside in a separate account, indicating they are collateral for a loan. Loans can also be made against cash held in an account at the bank or money market accounts. Some banks will also lend against assets like fine art. The assets need to be liquid and have a verifiable value.
Ideally, the borrower is making monthly payments consisting of principal and interest, similar to a conventional mortgage. It’s possible to have interest-only loans. There are also circumstances where the interest owed is added to the principal instead of being paid on a monthly basis. In that case, the loan grows and grows.
Can you borrow and make neither interest nor principal payments?
Financial services firms have offered margin accounts to investors for years. The stocks you currently own are the collateral. You can borrow up to a certain amount to buy more stock. Unlike a mortgage, the interest owed is added into the loan, making the margin loan or debit bigger. Some financial services firms have transitioned this into asset-based lending.
This example is similar to how a pawn shop works. The borrower brings in an item. The pawnshop owner determines how much they will lend against the item. The item is held as collateral. The loan amount grows because the interest is added to the loan. The borrower returns, pays off the loan plus accumulated interest, and is handed back the item they used as collateral.
You can see why this is risky for the borrower.
Calculating your asset-based loan
How much can you borrow? If you are borrowing using highly rated stocks, bonds or other traditional investment securities as collateral, the amount you can borrow might be about 50 – 70% of the account value. These are similar to the thresholds financial services firms use for margin loans. This doesn’t mean you need to take everything they offer! It can be set up similar to a line of credit, complete with a checkbook. This allows you to access funds as needed.
Things get more complicated when it’s a hard asset like a car, real estate, or artwork. Unlike liquid assets like cash and securities, they usually take longer to turn into cash. Cars depreciate and it isn’t always easy to find a buyer for artwork. The amount you can borrow isn’t as straightforward either. The bank will determine how much it will lend on a case-by-case basis.
How is the value of the asset determined? With cash, stocks, bonds, and money market funds, the value is pretty straightforward. With hard assets like artwork or real estate, a licensed, qualified appraiser is brought into the picture. They can provide an official valuation.
Pros and cons of asset-based financing
Here is a list of the benefits and the drawbacks to consider.
- Allows you to prequalify. It can be arranged ahead of time. The ability to borrow is there when you need it.
- No income verification. The loan isn’t dependent on your income. Why? Because they are lending based on the value of the collateral.
- Avoid the lengthy mortgage approval process. There isn’t a lag time while the bank considered the real estate you want to borrow and takes you through the loan approval process.
- No credit check. You are borrowing against an asset, not your credit.
- Asset Depletion Loan. Suppose you pledged one of your money market accounts at the bank as collateral and borrowed the full amount the bank allows. The bank collects monthly “mortgage payments” of interest and principal from the account on a regular basis. Your asset is gradually depleted. You might still be earning money market interest rates, but the interest rate on the loan is much higher.
- Your asset declines in value. This happens often when investors buy stock on margin in their investment accounts. In your case, you borrow the full 70% secured by your stock and bond portfolio. You aren’t buying more stock, you are pulling the money out. It’s an asset-based loan. The stock market declines sharply. Your stocks are suddenly worthless. The bank wants you to bring the account back into balance. This means you need to add fresh cash (which you don’t have) or sell securities at a bad time.
- Your retirement account is at risk. You have pledged one of your retirement accounts as collateral for the loan. Maybe you took a loan against your 401(k) account. Now suppose things didn’t work out the way you wanted and you can’t pay the loan back. The amount of the loan is now considered a distribution of retirement assets. This means it counts as taxable income. If you are under 59 1/2 there’s an early withdrawal penalty too.
Example of an asset-backed mortgage
The borrower is a wealthy retired person who has decided that investing in real estate is a good way to diversify their portfolio. They have $ 5,000,000 in stocks and bonds at a major financial services firm. They have no earned income because their income is from Social Security plus dividends and interest on their investments.
The borrower intends to spot attractive real estate deals that require closing quickly. They need easy access to cash. The borrower consults with their financial advisor about asset-based lending. They agree to pledge $ 2,000,000 of stocks and bonds, which are held in a specific account designating those assets as collateral for the loan. Although they might be able to borrow a maximum of $ 1,400,000, they intend to stay far below that level.
They see a property they would like to acquire. The seller is asking $ 1,2000,000. They approach the buyer and offer $1,000,000 with the understanding they have the funds available and can close immediately. The seller agrees.
The buyer now owns the property. They make monthly payments from their cash flow to cover interest and principal. After improving the property they put it up for sale, netting $ 1,300,000. They close the sale, pay off the remainder of the $ 1,000,000 loan and put the remaining proceeds into another account. They pay taxes on their capital gain.
The question “who qualifies” is simple to answer: People with sufficient assets in their own name qualify. These should be liquid assets like cash, money market funds, stocks, and other securities, but they can also be hard assets like artwork.
Which lenders offer asset-based mortgages?
Finding a mortgage if you don’t have a regular income is difficult. It is possible, however, if you have substantial assets to secure the mortgage. Most mortgage lenders don’t advertise their asset-based mortgage offers. However, there is nothing stopping them from using your assets to determine eligibility, so it’s always worth asking if you are interested in an asset-based mortgage.
Collateral for your asset-based mortgage
Collateral for an asset-based mortgage can fit into several categories:
- Cash and cash equivalents. You have a money market fund or Certificates of Deposit at the bank.
- Marketable securities. This includes stocks, bonds, mutual funds, and other easily negotiable securities.
- Hard assets. You can touch them. This can include real estate, cars, boats, airplanes, artwork, jewelry, and other items that can be appraised and sold, if necessary.
- Assets producing an income stream. You own nonqualified annuities. Maybe you published a book and collect royalties. You might be able to pledge these as collateral, although it’s logical the bank will want first claim on the income they produce.
Home equity financing
Using the equity you have built in a property to finance real estate investments is probably the most popular form of asset-based mortgage. You can use a cash-out refinance, a home equity loan, a HELOC, or a shared equity agreement.
Whatever method you choose, it’s important that you compare multiple lenders and investors before you make a decision. Simply getting quotes from three or more investors can save you thousands of dollars.
Frequently Asked Questions
Can you get a mortgage based on assets?
You can get a loan based on the value of assets pledged as collateral. If you are expected to make monthly payments containing both principal and interest, it behaves like a mortgage.
How do asset-based loans work?
You contact your financial institution, explaining you would like to borrow money, pledging certain assets as collateral. Together you agree on a value for those assets, often determined by a qualified appraiser, except when the price is readily available, like money market funds or marketable securities. The lender indicates how much they will agree to let you borrow, which is a percentage of the assets’ value. The assets are considered collateral and often set aside. The lender makes monthly payments, usually principal and interest.
Is a mortgage an asset-based loan?
A mortgage might be considered an asset-based loan because the asset is real estate. The bank lends an amount that is less than the total value of the property. The borrower makes principal and interest payments to retire the loan. However, mortgages are usually associated with real estate while asset-based loans can be made on different types of properties.
Should you insure the asset?
If you are borrowing against money market funds or securities held at the financial institution, insurance isn’t an issue. However, if you are borrowing against a hard asset like a car or artwork, you need to protect yourself in case it’s stolen. If it’s real estate, you want protection against damage. The bank will still want its money.
Is asset-based lending good?
Yes, because it gives you more flexibility when borrowing money. You can borrow money to pay for a property without using the property itself as collateral, thereby speeding up the buying process.
- If you want to buy real estate, using the property itself as collateral for the loan isn’t your only option.
- You can set up a loan facility ahead of time by borrowing against other assets through asset-based lending.
- Expect to make regular monthly payments of principal and interest, similar to a conventional mortgage.
- The amount you can borrow against assets is determined by the liquidity of the assets.
- The value of the assets is determined by a third-party appraiser, unless the collateral has a known value, like listed securities.
- When you borrow against assets, you place them at risk.
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Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book, “Captivating the Wealthy Investor” is available on Amazon. Bryce spent twenty years with a major financial services firm as a successful financial advisor. He has been published in 40+ metro market editions of American City Business Journals, Accountingweb, NAIFA’s Advisor Today, The Register, LifeHealthPro, Round the Table, the Financial Times site Financial Advisor IQ and Horsesmouth.com.