A non-purpose loan is a loan extended by a broker or a dealer using the securities in an investor’s account as collateral. They cannot be used to buy, carry, or trade securities such as stocks or bonds. Non-purpose loans are subject to strict regulations to ensure that brokers and dealers do not lend people more money to buy securities than the Securities and Exchange Commission allows.
Definition and Examples of a Non-Purpose Loan
A non-purpose loan enables a borrower to use the value of securities they own, such as stocks or mutual funds, as collateral for reasons other than purchasing additional investments.
TD Ameritrade's Collateral Lending Program is an example of a non-purpose loan. Investors who have security holdings with TD Ameritrade can borrow against their investment account to cover a number of purchases, including:
- Business expenses
- Educational expenses
- Real estate purchases
- Luxury purchases
- Short-term cash-flow gaps
A similar offering from Charles Schwab is its Bank Pledged Asset Line. This lets borrowers leverage their portfolios to access a line of credit that can be used for home renovations, tax payments, a vacation, a new business startup, and more, up to $100,000.
How Does a Non-Purpose Loan Work?
If an investor has securities in their account, they may be eligible for a non-purpose loan. This would allow the investor to keep their money invested and continue earning returns and dividends. Investors may be able to borrow between 50% to 70% of their diversified investment portfolio, although the amount can vary depending on lender requirements.
Investors who secure non-purpose loans must keep the securities guaranteeing the loan in a separate, fully paid-for cash account. If the value of the account with the securities acting as collateral declines below the level required for the securities to guarantee the loan, the investor may be subject to maintenance calls. These calls notify the investor to either deposit more funds or repay the loan within a limited time period. If the investor fails to do either, the securities may be liquidated.
The Federal Reserve requires all borrowers to complete a compliance form agreeing to the non-purpose loan terms and related obligations.
Non-Purpose Loans vs. Margin Loans
Investors may also take out another type of loan against the value of their securities: a margin loan. Margin loans involve borrowing to buy more stock and using existing stock as collateral. There are strict requirements for margin loans, including minimum deposit requirements, and investors can only borrow up to 50% of the purchase price of securities that can be purchased on margin.
Non-purpose loans are very different from margin loans because they specifically prohibit using the borrowed funds to buy securities. Investors can borrow a larger percentage of the value of their accounts (depending on the broker’s policy).
Non-purpose loan money cannot be used directly or incidentally to invest in stocks, bonds, or other similar investment products.
Pros and Cons of a Non-Purpose Loan
Non-purpose loans have some significant advantages and disadvantages.
- Lower interest rates
- Securities can be used as collateral
- Expedited approval process
- No closing costs or fees
- Additional collateral may be required
- Interest rates can increase at any time
- Your use of funds may be restricted
- Lower interest rates: Rates are often lower than they are for other types of loans.
- Securities can be used as collateral: Investors can use their securities to help them qualify for a loan without having to sell their investments.
- Expedited approval process: Often, less documentation is required to get approved for a non-purpose loan rather than with more traditional lending products.
- No closing costs or fees: There are no closing costs or other up-front fees with most non-purpose loans.
- Additional collateral may be required: Investors could be forced to deposit additional money or sell securities if the account balance dips too low while the account is acting as collateral.
- Interest rates can increase at any time: Interest rates can rise and loans can become more expensive.
- Your use of funds may be restricted: While your investment account is acting as collateral, you may be restricted in what you can do. For example, you may not be allowed to trade options.
Alternatives to a Non-Purpose Loan
Secured loan: A borrower could take another type of secured loan, such as a mortgage loan, which would be secured by the value of the home used to purchase the property.
Unsecured loans: A borrower could take out an unsecured loan, such as a personal loan, which does not require collateral to guarantee the lender is paid. Loans not guaranteed by securities often carry more stringent qualifying requirements, such as a full assessment of credit and income to determine the likelihood a borrower will repay the debt. These may have a higher interest rate than non-purpose loans.
- Investors can use the value of their securities as collateral to get approved for a non-purpose loan.
- Non-purpose loans allow investors to maintain their investment account balances while gaining access to cash.
- There are strict rules as to how much investors can borrow against their accounts to make other securities investments.
- Non-purpose loans are different from margin loans, which use securities as collateral in order to purchase other investments.
- Borrowers may need to complete a form specifying how much they are borrowing and what the non-purpose loan proceeds will be used for.