In many parts of the country, the real estate market is red hot. People are moving from large urban areas to areas that were once considered “vacation destinations” now that work-from-home (WFH) is so acceptable. Also, more than 10,000 baby boomers a day are retiring and looking to downsize their home. One question we get fairly often is “how do I buy a home with cash when a large part of my assets are tied up in investments and my current home?”
Today’s real estate market moves fast and many sellers won’t entertain a bid that comes in with a mortgage contingency. How do you make yourself a more attractive candidate to a seller? The answer may be by creating a Pledged Asset Account.
What is a Pledged Asset Account
A Pledged Asset Account is an account that offers collateral to the lender in exchange for a loan. For example, perhaps you have an $800,000 investment account that contains large capital gains. You have a home that you own free and clear that is worth $700,000, and you have found a home that you’d like to buy for $500,000 but you know the seller will most likely entertain only cash bids.
In this case, you could open a Pledged Asset Account with your $800,000 investment account, put those investments up as collateral, and borrow as much as 70% of the value of your account ($560,000). The $500,000 home you found could be purchased without a mortgage contingency by writing a check to the seller. Your investments don’t have to be sold, you don’t generate capital gains, and you can take your time selling your current home.
Pledged Asset Account Versus Margin Account
Brokerage companies have offered margin accounts for years: accounts that let you borrow up to 50% of the account value. However, margin account interest rates are significantly higher than Pledged Asset Account interest rates. For example, Charles Schwab currently offers margin accounts at 6.575% for $500k, but offers Pledged Asset Account rates at 3.35%. That’s a difference of more than $16,000 a year on a $500,000 loan. Also, margin accounts are often limited to 50% of account value, while Pledged Asset Accounts are limited to approximately 70% of account value.
Pledged Asset Account Example
Martha has an $800,000 investment account that has grown over the years and has $400,000 in gains. She owns a $700,000 home that may take 6 months or more to sell. She has found a $500,000 home she’d like to buy, but she doesn’t want to sell $500,000 in securities because it would generate $250,000 in capital gains and $37,500 in capital gains taxes.
Martha opens a Pledged Asset Account, she writes a check for $500,000 for her new home, she puts her current home on the market, and 6 months later her current home sells. She takes the $700,000 in proceeds, pays off her Pledged Asset Account Loan of $500,000, and has zero capital gains because she didn’t sell any securities to raise money. She paid approximately $8400 in interest over the 6 month period she had the loan.
Leveraged Accounts Are Not for Everyone
Loans, whether margin or Pledged Asset, are not for everyone. However, like any other tool out there, they can be highly useful and save time and money in the right situations. We welcome your questions or comments on Pledged Asset Accounts.