What are the Pros and Cons of Loan Stock?

Malcolm Tatum

Loan stock is shares of common or preferred stock that is currently in use as security or collateral on some type of loan arrangement. Sometimes known as portfolio loan stock financing, this approach may utilize a loan that is either secured or unsecured as part of the investment strategy. In either case, the process makes it possible to enjoy returns in the form of a fixed interest rate that is attached to the loan. In the event that there is a default on the loan, ownership of the pledged shares of stock is transferred to the lender who may choose to hold the shares or sell them in order to offset the loss.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

There are several benefits associated with the idea of loan stock. Investors who are in need of a loan for some purpose but do not wish to pledge real estate holdings may utilize a portion of an investment portfolio as the security for the lending arrangement. For the duration of the loan, the investor still enjoys all benefits related to holding those shares, including the receipt of dividends generated by the shares. In some cases, the borrower may use those dividends to help retire the balance of the loan, making it possible to settle the loan in full in advance of the due date.

One drawback to a loan stock arrangement is that the investor is not free to sell the shares at will during the course of the loan. In order to do so, the borrower must confer with the lender and receive permission to initiate a sale. Depending on the balance remaining on the loan at the time permission is granted to sell the pledged shares, the lender may lay claim to the proceeds from the sale to settle the balance, or require the borrower to provide some other asset as collateral, possibly other stocks currently found in the portfolio.

There is also the chance that if the pledged shares significantly decrease in value during the course of the loan, the investor will find it necessary to pledge additional stock holdings for the loan. This approach would increasingly prevent the investor from freely trading assets held in the portfolio, possibly preventing the investor from engaging in trades that show promise of being lucrative. While the concept of loan stock is often attractive for certain types of loans that are likely to be settled with five years or less, using this approach may not be in the best interests of the borrower if the loan is for an extended period of time.

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