Case Background
Deb Johnson needed $10,000 for a house down payment. Advised by her broker, she used $3,000 worth of stock as collateral to borrow the amount instead of selling it.
Recommendation Analysis
For several reasons, getting a loan secured by securities is better than an unsecured loan. First, even such a pledge can improve the bank’s offer at an annual rate. Secondly, in case of successful repayment of the loan, the borrower’s assets are returned; in this way, the long-term preservation method is implemented (He, 2021). On the other hand, unlike real estate, such collateral is more subject to fluctuations in market value.
In case of difficulties in making payments, such collateral can significantly reduce its value and not help with loan repayment. In addition, the value of the pledged securities is much lower than the loan amount, substantially increasing the risks of such a loan. Without a proper, detailed assessment of the relevance and liquidity of securities assets, taking into account their potential volatility, their sale would have a more reliable value fixation within the framework of asset relocation. In other words, by selling the shares for $3,000 now, Deb Johnson has locked in their value and invested the money in a down payment on a mortgage, protecting herself from price dynamics and reducing bank collateral risks.
However, the broker’s advice makes the most sense due to several factors, so I agree with their recommendation. First, Deb Johnson is exempt from paying capital gains taxes on the sale of shares (Purnamasari, 2019). Secondly, a secured credit line provides low interest rates, which makes it possible to reduce overpayment.
Finally, as a borrower, Johnson becomes most attractive to banks, and this move can improve the credit history and provide long-term cooperation with the borrower. However, the decision depends on the liquidity and diversification of the Deb Johnson portfolio, as in this case, there are risks of expanding collateral when the share price falls, and in such a replacement collateral scenario, she will have to look for additional funds to pay off the debt early or purchase securities to maintain interest secured loan rates.
References
He, S. (2021). Growth, innovation, credit constraints, and stock price bubbles. Journal of Economics, 133(3), 239-269. Web.
Purnamasari, D. (2019). How the effect of deferred tax expenses and tax planning on earning management?. International Journal of Scientific and Technology Research, 8(2), 78-83.