What is a Non-Purpose Loan?
A non-purpose loan is an alternative type of loan that often involves using investment securities as collateral and relies on complex structuring. Regulated non-purpose loans can be offered by brokerages and financial institutions with some specific government-regulatory documentation requirements.
How a Non-Purpose Loan Works
Regulated non-purpose loans allow a borrower to use an investment portfolio as loan collateral but the proceeds cannot be used for purchasing, carrying or trading securities. One advantage of this type of loan is that it gives investors access to funds without having to sell their investments.
Generally, non-purpose loans may also be featured as a lending category across a variety of lending platforms. Typically, lenders will require a borrower to specify a loan purpose for a personal loan. This is especially important with online lending platforms where retail and institutional investors choose to invest in loans by their particular purpose.
Regulations require financial institutions to disclose whether a loan is a non-purpose or purpose loan. This is regulated by the Federal Reserve under Regulation U. Borrowers obtaining a non-purpose loan must complete a compliance form detailing the terms of the loan and its non-purpose obligations.
Loan Platform Categories
In general, online loan platforms may also offer non-purpose loans which are personal loans obtained by borrowers with no specific purpose for their use. Online lending investors in platforms such as Lending Club or Prosper will often invest in platform loans based on the loan’s purpose so this classification can also provide a consideration in investment risk analysis.
Non-purpose loans give investors access to funds without having to sell their investments.
Non-Purpose Loan vs. Margin Loan
Non-purpose loans are considered an alternative to traditional margin borrowing because they allow multiple investment accounts to be used to secure a loan. Both non-purpose and margin loans will allow investors to continue to receive the benefits of their portfolio holdings, such as dividends, interest, and appreciation. Both are also subject to a margin call if the value of the pledged securities declines below the specified limit. Nonetheless, there are differences between these two types of borrowing.
Non-purpose loans are typically marketed as securities backed lines of credit (SBLOCs). They are generally more complex to obtain than a standard margin loan. And, as noted above, they cannot be used to buy securities whereas margin loans are typically used for the sole purpose of investing in securities.
Brokerages offer margin loans on individual investment accounts. SBLOCs offer borrowers the opportunity to obtain a loan through the use of multiple account investments. Some SBLOCs may require a specific account to obtain the lending proceeds.
Example of a Non-Purpose Loan
Charles Schwab provides one example with its Pledged Asset Line of Credit product. Generally borrowers can access up to 70% of their collateral assets as cash through the loan agreement. Terms of up to five years are available and the only applicable fees are late fees. Like all non-purpose loans, the Schwab's Pledged Asset Line cannot be used to buy securities.