Cash is king – and sometimes, you need access to cash unexpectedly. In a client’s case last week, they found themselves with a great real estate opportunity that involved purchasing a new home in advance of selling their current home. They needed access to cash for a very short period of time (less than a month). Here are the options I discussed with them (which may be helpful if you find yourself in a cash crunch!)

Home Equity Line of Credit – I wrote about these useful tools in a prior post. A home equity line of credit allows you to tap your home’s equity (ie: taking out a loan with the house as collateral) and pay interest only on the drawn balance until you are able to repay. In the end, this is the option that worked best for my client. They used a home equity line on their current home to obtain liquidity for the new home purchase. Once their current home sells, the line will be paid off and all will be well!

Margin Line – Another option for short-term liquidity is to borrow against a non-retirement investment account. This is known as a margin line. As with a home equity line of credit, you are borrowing against an asset. Given that the asset is an investment account vs. a piece of real estate, the interest rates tend to be a higher than a HELOC.

You must first apply for the margin feature to be added to your account. A rate of interest will apply, which is negotiable to some extent with each custodian. Here is a list of the pre-negotiation current rates at Schwab. Rates are variable and decrease the higher your margin loan. Margin loans can present considerable risk as your available loan balance (referred to as a debit balance as you essentially take cash negative) is based upon your the market value of your investment balance on a minute-by-minute. Usually, you are limited to 50% of the margin-eligible investments in your account. As a result, if you borrow right up to that limit and your account value then falls, you will be required to pay back a part of your loan immediately (known as a margin call) to restore your loan to that max level. For this reason, if margin is used, I always encourage clients to stay far below that 50% limit.

Despite their high rates of interest and concerns over margin calls, they can prove very useful. It allows you to get access to cash without any underwriting. Further, if your investment account is comprised of positions with meaningful unrealized gains, the interest expense over a short time period is often a lower dollar amount than the taxes you would owe on the capital gains if they were realized

Side Note: margin can also be used to “double-down” on the market. Investors will take out a margin line and use it to purchase additional securities, thereby providing added exposure to the market. This is a very risky strategy (as markets move in both directions) so we do not advise this approach to most investors. If you pursue this – please do so with extreme caution!

Pledged Asset Line – A pledged asset line is very similar to margin in that you are borrowing and using your investments as collateral. However, the pledged asset line is issued by a bank (versus a broker dealer) and require the pledged assets to be placed in a segregated investment account. Unlike a margin line, the funds cannot be used to buy more securities, nor can the funds be deposited into any brokerage account. Some custodians (like Schwab) offer pledged asset lines thru their banking subsidiary.

Pledged asset lines typically lend a bit more as a percentage of the account balance than margin lines (usually up to 70%). However, they do have initial draw requirements (for instance, require you to take $70,000 of a $100,000 initially, then allowed to take smaller draws – whereas margin lines have no such requirements). Since the draws are required to be larger, the rates are lower (here are Schwab’s current rates).

Give that pledged asset lines require you to take a large upfront draw, they tend to be best suited for material cash needs or material bridge financing, where the balance needed, while large in magnitude, can be paid off in relatively short order.

Lastly, similar to margin, investments are acting as your collateral so if there is a material market correction, you may be faced with a repayment demand from the bank.

Liquidate Investments – If cash is needed, there is also the option to liquidate securities and use invested funds for cash needs. However, there can be very material taxation impacts using this option (that oftentimes far outweigh interest expense on the above options). If you use a retirement account, you may be looking at added ordinary income tax (as distributions from non-roth retirement accounts are taxable as income) as well as excise penalties if you are under age 59.5. If you used non-retirement accounts, you may be looking at capital gains taxation as well as the additional Medicare surcharge on Net Investment Income, depending on your tax situation.

As with all decisions, the right approach for you will depend on your situation buy very rarely is liquidating your investment account the best solution for short term cash needs -due to taxation but also due to the opportunity cost of being out of the market. So if you find yourself in this situation, consider the other three ideas listed above and see which one will serve you best.

Hopefully this helps you evaluate potential courses of action if you too find yourself in a cash crunch!