Non-Purpose Loan

Posted on by user

Non-Purpose Loan — What It Means and How It Works

Key takeaways

  • A non-purpose loan uses investment securities as collateral but cannot be used to purchase, carry, or trade securities.
  • It lets investors access cash without selling holdings while retaining dividends, interest, and appreciation.
  • U.S. lenders must disclose whether a loan is a non-purpose loan under Federal Reserve Regulation U.

What is a non-purpose loan?

A non-purpose loan is a loan secured by investment securities (for example, stocks or bonds) where the proceeds are prohibited from being used to buy or carry securities. These loans are commonly structured as securities-backed lines of credit (SBLOCs) and are offered by brokerages and financial institutions with specific regulatory disclosures and compliance requirements.

How it works

  • The borrower pledges investment accounts as collateral and receives cash or a line of credit based on a percentage of the portfolio’s value.
  • Collateralized accounts typically continue to earn dividends, interest, and potential appreciation.
  • Lenders monitor collateral value; if it falls below required levels, a margin call or requirement to add collateral may occur.
  • Borrowers must typically sign a compliance form confirming the loan’s non-purpose restrictions.

Loan platform categories

  • Traditional brokerages and banks offer regulated non-purpose loans (often SBLOCs) for clients with investment assets.
  • Some online lending platforms classify loans by stated purpose; on peer-to-peer platforms, a “no specific purpose” classification can affect investor demand and risk assessment.

Non-purpose loan vs. margin loan

  • Purpose: Margin loans are intended to finance the purchase of securities; non-purpose loans explicitly prohibit using proceeds to buy securities.
  • Collateral use: Margin loans are usually tied to a single brokerage account; non-purpose loans/SBLOCs can sometimes use multiple accounts.
  • Complexity: SBLOCs are often more complex to establish than standard margin loans.
  • Both types allow owners to retain portfolio benefits and are subject to margin calls if collateral declines.

Example

A typical SBLOC might allow a borrower to access up to a set percentage (for example, up to 70%) of pledged assets as cash with fixed-term or open credit arrangements. Fees are commonly limited to interest and possible late or maintenance fees; the line cannot be used to purchase securities.

Regulation and compliance

In the United States, Regulation U (Federal Reserve) requires financial institutions to identify and disclose whether a loan is a purpose or non-purpose loan. Lenders must ensure borrowers understand and agree to restrictions on the use of proceeds.

Considerations before borrowing

  • Advantages:
  • Access to liquidity without liquidating investments (avoids triggering taxes or losing market exposure).
  • Retain dividends and interest from pledged securities.
  • Risks:
  • Market declines can trigger margin calls or forced liquidation of collateral.
  • Restricted use of funds (no investment in securities).
  • Potentially complex terms and covenants.

Conclusion

Non-purpose loans provide a way to convert portfolio value into cash while maintaining market exposure, subject to regulatory restrictions and collateral risk. Evaluate terms, allowable uses, monitoring rules, and the lender’s compliance requirements before borrowing.