A non-purpose loan is a unique type of loan that leverages investment securities as collateral while inherently relying on intricate structuring. Offered by brokerages and financial institutions, these loans necessitate specific regulatory documentation to meet government requirements.
Key Takeaways
- Innovative Structuring: Non-purpose loans use investment securities as collateral.
- Continuous Portfolio Benefits: These loans allow investors to benefit from dividends, interest, and appreciation without liquidating their investments.
- Regulatory Compliance: Financial institutions must report non-purpose loans to the Federal Reserve under Regulation U.
How a Non-Purpose Loan Works
Non-purpose loans provide a financial avenue for borrowers to use their investment portfolios as collateral, all while preventing the use of the funds for buying, carrying, or trading securities. The primary advantage is that it grants investors access to liquidity without necessitating the sale of their investment assets.
Typically featured across various lending platforms, lenders often require borrowers to specify the loan purpose, particularly on online platforms. This category is crucial as both retail and institutional investors tend to base their investment decisions on the loan’s disclosed purpose, thereby factoring this into their risk analysis.
Ensuring transparency, regulations mandate that loans are categorized as either non-purpose or purpose loans, a disclosure regulated by the Federal Reserve under Regulation U. Borrowers availing a non-purpose loan must fill a compliance form outlining the loan terms and its non-purpose stipulations.
Loan Platform Categories
Online lending platforms commonly offer non-purpose loans as personal loans without a specific usage purpose. Investors on platforms like Lending Club or Prosper often choose loans based on the classified purpose, aiding in evaluating investment risks. Non-purpose loans enable investors to access funds without having to sell their investments.
Non-Purpose Loan vs. Margin Loan
Contrary to traditional margin loans, non-purpose loans allow the use of multiple investment accounts to secure the loan. Both loan types allow beneficiaries to receive dividends, interest, and appreciation benefits from their portfolio. Additionally, they are both susceptible to margin calls if the pledged securities’ value falls below a certain threshold.
Often marketed as Securities Backed Lines of Credit (SBLOCs), non-purpose loans are more complex to acquire and are not for the purpose of purchasing securities, unlike margin loans typically intended for investing in securities. While brokerages provide margin loans on individual investment accounts, SBLOCs allow leveraging multiple account investments for loan proceeds, sometimes necessitating a specific account to secure the loan.
Real-World Example of a Non-Purpose Loan
Consider Charles Schwab’s Pledged Asset Line of Credit product as an example. Borrowers can obtain up to 70% of their collateral assets in cash under this agreement, with terms extendable up to five years, strictly with only late fees applicable. Schwab’s Pledged Asset Line, like all non-purpose loans, forbids using the loan to purchase securities, offering a secure way to access cash.
Related Terms: collateral, margin loan, Regulation U, securities-backed line of credit
References
- Board of Governors of the Federal Reserve System. “Compliance Guide to Small Entities - Regulation U: Credit by Banks or Persons other than Brokers or Dealers for the Purpose of Purchasing or Carrying Margin Stocks”.
- Lending Club. “Manual Investing”.
- Prosper. “Browse Listings”.
- Charles Schwab. “Pledged Asset Line”.
