Why Are Rich People Still Borrowing?

There’s a personal finance cliché that debt is the devil.

That makes sense to me when it comes to a burdensome debt like this. carrying a credit card balance.

But the more time I spend on wealth management, the more I realize that using debt wisely can make sense, even if your net worth is high. Many rich people use debt as a tool.

When Mark Zuckerberg bought his house in California, 30 year fixed rate mortgage. Elon Musk reportedly There is more than one mortgage on more than one property.

Why do rich people borrow?

There are several reasons.

You don’t want to sell other assets and pay taxes. You don’t want to interrupt the composition. You want to diversify and avoid putting too much cash into a single asset. Debt can also be an inflation hedge in the long run.

These reasons don’t just apply to mortgages. People also borrow against their portfolios. I know this may seem disrespectful to some, but under the right circumstances it can be a useful form of borrowing.

Frankly, the biggest risk when borrowing against your portfolio is getting a margin call. You need to think long and hard about the amount of money you want to borrow and understand how a stock market crash could affect this type of loan.

However, portfolio loans are extremely flexible. Getting a loan through a bank can be a tedious process with a lot of paperwork and headaches. Portfolio loans can be finalized much faster.

Most major brokerage platforms and banks offer security-backed lines of credit (SBLOCs), which allow you to borrow against your portfolio.

One of the disadvantages of these loans is that borrowing rates can be relatively high; Something like the risk-free interest rate plus 2-4% or so. This would be higher than mortgage rates for most borrowers.

But now there are other options.

Bloomberg There was a story late last year that caught the attention of financial advisors and wealthy investors alike:

Here is the led:

With the housing market overheating and the Federal Reserve’s benchmark interest rate hovering near zero in late 2021, Tony Yang found an unconventional way to finance his down payment.

He logged into his Charles Schwab brokerage account, made a trade he discovered on Reddit, and unlocked nearly $650,000 to help finance a home in the Bay Area.

The so-called “box spread” trade carried something of a mystery. Yang created a strategy that mimics a fixed-rate loan by combining two opposing option positions (one bullish, the other bearish): cash upfront immediately, repayment on a set date, and a fixed cost in between.

Yang used it to borrow just 1.6% over five years, well below the traditional mortgage rate, and create a down payment without having to sell assets he wanted to keep in the market.

This 1.6% box spread financing rate was back when interest rates were much lower. It’s higher now because the rates are higher.

But check out Bloomberg’s recent comparison of borrowing costs:

Using your portfolio as collateral for a box spread loan offers a much lower interest rate, closer to the risk-free rate.¹

I am not an options trader, but let me explain how these box spread loans work at a high level from the borrower’s perspective:

• You use your portfolio as collateral for an options position.
• How much you can borrow depends on the securities.
• The length of the period varies from month to month to approximately five or six years.
• There is no monthly payment.
• There is no interest due until the expiration date.
• The “interest” paid on the loan is actually considered a loss for tax purposes.
• When the loan expires you can choose to pay it off or roll it over to a new box spread position.

If you don’t have experience with these instruments, this can range from sounding too good to be true to overwhelming feeling that is hard to understand.

So I invited Joseph Wang of SyntheticFi over at Talking Wealth to discuss:

• How do box spread loans work?
• Why are these loans relatively new to some but have been around for a long time?
• Usage situations of these loans.
• My personal box spread scenario.
• How does SyntheticFi work with financial advisors?
• The risks involved in the process and more.

Watch here:

Podcast version here:

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Further Reading:
Why Can I Never Pay My Mortgage?

¹Whatever additional fees arise at maturity levels similar to Treasury interest rates, depending on the duration of the loan.