3 Types of Debt To Achieve Your Financial Goals

3 Types of Debt To Achieve Your Financial Goals

Leverage is the use of borrowed money to invest, This type of debt can be a part of your personal financial strategy if you explore it in moderation and use the right tactics.

  • To Achieve Your Financial Goals, Employing debt can serve as an intelligent financial and investment strategy 
  • One approach is to use liquid asset secured financing or home equity line of credit to leverage your investment portfolio.
  • Additionally, you may consider specific life insurance policies and trusts that can aid in wealth transfer and reduce taxes for your beneficiaries.

Here Are The 3 Types of Debt To Achieve Your Financial Goals

1.Liquid asset secured financing

A liquid asset secured line of credit utilizes your investment portfolio as collateral instead of your home. By using this method, you can obtain liquidity without selling assets and possibly incurring capital gains taxes. Liquid asset secured financing is a suitable choice if you need to generate cash flow swiftly. Moreover, it offers lower interest rates as it is considered a lower-risk option.

Uses for liquid asset secured financing include:

  • Funding special purchases
  • Paying a tax bill
  • Refinancing higher interest rate debt

Liquid asset secured financing is a dynamic line of credit that is secured by eligible assets held in one or multiple investment accounts.

In essence, your investment portfolio is used as collateral against a loan.” During a volatile market, it becomes crucial not to liquidate investment assets. With liquid asset secured financing, you can have greater liquidity and financial flexibility.

How to use your assets as cash

Liquid asset secured financing, also referred to as securities-based or portfolio line of credit, does not necessitate personal financial statements or tax returns for loans up to $5 million (although a loan application and underwriting are still required, similar to other lending options). This financing option provides competitive interest rates and adaptable principal repayment options for both commercial and consumer clients. Furthermore, liquid asset secured financing offers a straightforward application process, accelerated approval procedures, and immediate access to available funds.

You can use the cash to meet a wide range of financial needs:

  • Pay taxes
  • Quickly finance special purchases, such as a cash offer on real estate
  • Manage short-term cash flow
  • Serve as a bridge loan
  • Refinance higher interest rate debt

The flexibility and liquidity offered by this line of credit make it especially valuable in situations where you are faced with unexpected financial opportunities or challenges. Additionally, it provides better financial management options.

For instance, if you need funds to close on a new home but your investment portfolio is down due to market volatility, you may not want to sell securities at a loss. In such cases, you can opt for a line of credit secured by your portfolio to generate the necessary cash.

Similarly, small business owners who need cash to cover temporary expenses such as payroll can obtain a line of credit secured by their business or personal portfolio. According to Chow, even nonprofit organizations are taking advantage of these types of loans. For example, when donations and grants fall short in a particular year, a nonprofit may struggle to align the timing of projects. Rather than selling endowment funds or seeking costlier financing options to cover operational expenses, a nonprofit can use a portion of the endowment fund as collateral without disrupting overall investment objectives.

Considerations with liquid asset secured financing

It’s crucial to consider the current economic climate and associated borrowing costs when evaluating liquid asset secured financing, as with any financing alternative.

Interest rates : Liquid asset secured financing usually offers adjustable interest rates, meaning the interest you pay on the loan is linked to a benchmark rate. In general, as interest rates increase, the amount of interest you’ll pay on your loan will also increase. To take advantage of favorable interest rates, it’s wise to secure financing now if you anticipate interest rates will rise in the future.

It’s also important to consider the length of time you need before you can repay the loan. Shorter-term funding needs, such as those lasting a few months to a few years, are better suited for liquid asset secured financing to minimize your exposure to fluctuations in interest rates. For mid- to long-term financing needs, it may be more appropriate to consider a fixed-term interest rate loan.

Market volatility :

As the amount you can borrow with a liquid asset secured loan is linked to the value of your entire portfolio, any decline in the market will result in a decrease in the value of your collateral. If the value of your collateral drops, you may be required to adjust the outstanding loan amount to align it with the overall value of your portfolio. This is referred to as a margin call. In such a scenario, you may need to repay a portion of your loan, provide additional collateral, or sell some of your assets, which could result in a tax liability.

According to Chow, “We keep a close eye on the market daily, and any fluctuations are immediately detected. We will then work with you to address the issue and bring the account back to margin as soon as possible.” It is important to consider having a secondary funding source or a way to easily pay down the line of credit or add more eligible collateral in the event of a margin or maintenance call.

In addition, a drop in the market could also result in a reduction in the amount you can borrow since it is directly linked to the value of the assets you are using as collateral. Therefore, if the value of your collateral declines, your flexible line of credit will also decrease.

2. Home debt

A home not only serves as a valuable asset but can also be leveraged to obtain equity. This equity can be utilized to finance various expenses such as buying a second home, renovating an existing home, or acquiring a commercial property. This approach can potentially generate income while also providing portfolio diversification.

It is important to note that leveraging your home carries higher risk and may not be suitable for those with a low risk tolerance. The advantages of real estate investments are clear:

  • If you believe the real estate will appreciate, you can access liquidity without selling the property and missing out on potential future gains in value
  • You may be able to rent out a second property, generating additional income
  • Small business owners may be able to use money from a second mortgage to fund their business at a lower rate than what’s available to the business entity

When to consider a home equity line of credit (HELOC)

A variable-rate home equity line of credit (HELOC) can be a suitable option if you require additional funds periodically. Once you’re approved for a maximum line amount, you can withdraw the funds as needed. You can use your Home Equity Line of Credit Visa Access Card to make purchases anywhere Visa is accepted, or transfer the money to your U.S. Bank savings or checking account through Online or Mobile Banking, visit a branch or ATM, or write a check. You’ll have access to the funds for ten years, called the draw period, from the day you open your line of credit. Following the draw period, you’ll have a repayment period of 20 years.

The monthly minimum payments on your HELOC are variable and depend on the line balance and the variable interest rate. As you pay back the borrowed money, the funds become available again on your HELOC. This renewable source of funding is beneficial during the draw period and can be helpful if you anticipate making periodic payments for things like tuition or remodeling.

However, it’s essential to consider several critical factors when deciding whether a home equity line of credit is right for you.

  • You have to pledge your home as collateral
  • If you don’t make payments, your property can go through foreclosure
  • Your credit score is on the line if you aren’t diligent with your payments

Home equity loans and lines of credit are a good choice for many people. The mortgage interest may be deductible, and these second mortgages allow you to use the equity in your home to pay for major expenses. Contact a banker or come into one of our many U.S. Bank locations for more information so they can work to understand your needs and provide options.

3. Estate planning debt

Contrary to popular belief, debt can facilitate wealth transfer. Two estate planning strategies in particular can help: life insurance policies and grantor retained annuity trusts (GRATs).

Leverage a life insurance policy

Add this as another reason to have life insurance: You can use your policy to help pay for estate taxes after your death. Leveraging your life insurance policy allows the estate to distribute assets at a pace that maximizes the estate’s value.

Mook notes that insurance can be expensive. “If you don’t want to write a large check every year,” he says, “you can finance that premium and use the cash value of the policy or other assets as collateral for the loan.”

Grantor retained annuity trust (GRAT)

A GRAT is an irrevocable trust set up for a short period of time (usually two to five years) that helps transfer assets to beneficiaries in a tax-efficient way. You place assets into the trust and the trust pays you a fixed annuity each year, usually a set percentage of the original amount of assets. Over the life of the GRAT, the assets will inevitably rise and fall in value.

Bank financing could help protect your gains and shield you from losses by allowing you to substitute a stable asset for a high-growth one. For example, substituting cash for stock secures any gains in the stock value to date. If you don’t have the cash to make that substitution, a bank can lend it to you.

When the terms for your GRAT are up, the remaining assets, including any appreciation on the assets, transfer to your beneficiaries tax-free. However, if you’re no longer alive when the GRAT terminates, the assets become part of the estate and subject to estate tax.

According to Mullen, GRATs are a popular method for individuals to reduce taxes on financial gifts to their beneficiaries. By establishing this trust, you can contribute assets and receive regular annuity payments, typically a fixed percentage of the initial asset value. The value of the assets in the trust may fluctuate over time.

Upon termination of the trust, any remaining funds, along with any appreciation, can be transferred to your beneficiaries free of gift tax. However, if you pass away before the trust ends, the assets become part of your estate and are subject to estate tax.

Alternatively, QPRTs offer another way to transfer assets, particularly real estate, to beneficiaries. Mullen explains that if you wish to gift your home to your child but still plan to live in it, you can establish a QPRT for 10 years. If you survive until the trust terminates, the property passes to your child outside of your estate.

Both strategies aim to utilize time and appreciation to remove assets from your estate, with the ultimate objective of reducing estate taxes

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