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Securities-Based Loans, Credit Card Debt Rising to Worrisome Levels
Trump may like to say he’s ‘draining the swamp’ in Washington, D.C., but he’s apparently doing little to bail out consumer appetite for spending – and building up debt.
RISING CREDIT CARD DEBTS. Just last week, the Federal Reserve reported that Americans now owe $1 trillion in credit card debt, with an average monthly balance of about $9,600 for borrowers who don’t pay their cards in full each month. This means that 3 categories of consumer debt – credit card, auto, and student – each exceeds $1 trillion. That might sound bullish for the economy, until one considers that defaults in all 3 categories are rising. So, what’s the likely impact on credit card debt holders:
One year ago, a credit card holder making only minimum monthly payments paid out about $1185 in annual interest. After last month’s boost in interest rates, that same CC holder is now paying $1,254 in annual interest – an increase of $69. With 2 more projected interest rate hikes, that figure could rise to $1,301 a year - a $116 increase that just might be the ‘straw that breaks the camel’s (consumer’s) back’. [NYPost]
SECURITIES BASED LOANS. Another category of consumer debt that has financial insiders worried is securities-based loans. Securities-based lending, or securities-based borrowing, essentially means using one's investments as collateral to secure a loan. It is also known as "non-purpose lending," presumably because the loan proceeds can be used for a variety of purposes such as buying real estate, purchasing personal property like jewelry or a sports car, or investing in a business. SBLs cannot, however, be used to buy securities or to pay down a margin loan.
SBL became increasingly big business for broker-dealers and banks in the United States during the latter phase of the bull market that commenced in 2009, as share prices reached all-time highs and interest rates held at record lows for an extended period. While securities-based lending has benefits for both the borrower and lender, the risks are skewed towards the borrower. [Investopedia]
While SBL’s offer borrowers several benefits - e.g., lower interest rates, flexible payment terms, access to substantial amounts of money - they bear several drawbacks that fall principally upon the borrower:
- Forced liquidation - similar to margin calls, if and when collateral values plunge below the minimum balance required.
- Double-whammy - using volatile assets like stocks as collateral may be an effective strategy during an economic boom. But in recessionary times, a broad-based decline in values or prices can whack both collateral (securities) and invested assets ( e.g., a vacation home).
- Over-leveraging: A loan obtained by pledging securities is still a loan that has to be repaid at some time. Using leverage can be an issue if the loan is used to purchase a non-productive asset or finance a lifestyle, especially if the borrower already has a substantial amount of debt. It’s this 3rd drawback that leads some experts to suggest that consumers should simply sell securities to meet their expenses – particularly when they're nearing retirement.