It’s time to flip your mindset when it comes to loans. Stop thinking about working to pay them off. Start thinking about how they can work for you. In this #WealthInsights article, I explain three common types of loans and how the right structure can maximise financial gain and flexibility.
Financial flexibility is essential. To facilitate this, humans have been in the business of lending and borrowing assets for thousands of years. The first evidence of lending dates back to 2000 BCE Mesopotamia, when farmers utilised pay-day loans. Though today’s packaging of loans is more sophisticated, the concept of lending remains fundamentally unchanged. Let’s take a high-level look at three popular lending techniques: mortgages, Lombard loans and structured loans.
Housing forms the literal bricks and mortar of our daily lives. Tangibility makes mortgages relatively easy to understand: they are simply loans that allow you to buy a house or property to live in, holiday in, work in or rent out. The exchange between borrower and lender is straightforward: the real estate itself is pledged as collateral against the risk of default, covering the bank’s risk exposure and therefore allowing affordable interest rates.
But the difference between getting a loan, and getting the right loan determines whether you’re a slave to your mortgage or whether it works for you. Because you partially rely on borrowed money when financing your home with a mortgage, we are talking about a leveraged investment – meaning your potential for return on investment is higher should property prices rise. But this also means the potential for loss is greater should prices drop. And pricing drop could be compounded by a “margin call” – which is when the lender asks you to reduce your mortgage to a suitable level in reflection of the property’s decreased value.
It’s important to do your due diligence and ensure you can afford repayments even if interest rates rise or property prices slump.
So, how to make mortgages work for you? When it comes to residential property purchases, there’s a lot to consider. It’s important to do your due diligence and ensure you can afford repayments even if interest rates rise or property prices slump. Doing so requires keeping your head in reality. Financing your own home is one of the most important decisions you’ll make and there’s a very emotional element involved. The structure of your loan should be tailored deliver your dream real estate, while also maximising your return on investment and financial flexibility.
If you want to borrow money and are willing to provide listed securities as collateral, that’s Lombard lending in a nutshell. As long as the securities are listed, it doesn’t matter whether they are equities, fixed income, structured products or exchange-traded funds. The benefit is clear: you’re able to increase your financial flexibility while retaining your investment portfolio. Because the securities are listed as collateral they don’t need to be sold for you to obtain liquidity solutions, trade in derivative financial instruments that require a security margin or reinvest to further diversify your portfolio, for example.
Lombard loans are multipurpose loans that grant you full flexibility: the funds are totally at your discretion during the loan’s duration. Like all investments, potential rewards come with potential losses, and their nature means that Lombard loans are more exposed to fluctuations in the value of your securities portfolio. It’s therefore essential to ensure your repayment capacity covers all risk scenarios, including fluctuations in value.
There is no common definition of structured finance, which can be confusing. We define structured finance solutions – structured loans – as those where we offer a bespoke wealth financing facility. Put simply: structured loans are the ideal solution when standard policies and procedures don’t cut it. Of course, collateral is also needed to take out such a loan and its characteristics will be determined by whether your collateral comes from listed securities or private assets.
In the case of private assets being used for collateral, the exact lending solution created will depend upon which asset buckets are being borrowed against.
Depending on your situation, there are three types of bespoke types of lending solutions.
- ’Structured Lombard lending’ creates bespoke solutions for the pledging of complex portfolios, be they highly concentrated, large in size or multijurisdictional.
- ’Private debt Lombard lending’ uses a private asset pocket (real estate or shares in a private company, for example) as collateral to add to a security and structure a loan against.
- And ’strategic equity solutions’ entails structuring solutions for borrowers who have a strategic stake in a listed company and want to broker against it
Let’s consider some examples. One scenario could be an equity-rich but liquidity-poor shareholder of unlisted companies that’s happy to monetize against their private shares. Mortgages could also be structured to used as collateral: different real estates are brought together in one portfolio which is set against a structured lending facility. Alternatively, private equity holdings could be used as collateral to structure lending against. There are different potential constellations, and that’s the beauty of it.
Have your money work for you
Having a game-plan for your overall wealth management is a great framework for exploring which loan structure suits you best. In my experience, the most valuable mantra I’ve come across is: “hope for the best but plan for the worst”. The beauty of lending comes in finding the right solution, at the right price, with the right risk profile. It’s about having your money work for you.
Our monthly Wealth Insights series focuses on the most important moments in life – whether it is starting a business, building up a fortune, moving abroad, preparing for retirement or transferring wealth to the next generation. We ask the relevant questions and provide answers from a wealth management perspective.