What if you could spend a million
dollars and keep the investments that
made you rich? Some people borrow
against what they own, so they don't
have to sell it. You can make payments
for years and still owe the bank the
full million. The money they borrowed
will run out and the bank will
eventually want its money back. [music]
How they deal with that depends on how
much they own, what produces cash, and
what happens to their investments along
the way. So, how rich do you have to be
before a bank will lend you money
against what you own? Well, the bank is
interested in the investments it could
sell if you don't repay the loan. Shares
in widely traded companies are one
example because their price is visible
and they can usually be sold quickly.
But, that doesn't mean the bank will
lend someone the full value of their
shares. No, if you own $200,000 in
investments, a bank might offer a much
smaller credit line, subject to which
investments you own and its own rules.
Some banks require at least 100,000 in
eligible investments just to open up
this kind of account. Qualifying at that
level doesn't mean the loan will cover
your life, though. Say you borrow 50,000
and spend $50,000 a year. You've bought
yourself one year of spending and you
still owe that 50 grand. [music] But
now, say someone owns $10 million in
shares and spends 200,000 a year. If a
bank lends them a million against those
shares, they can draw money for several
years while keeping what they own. The
shares give the bank a reason to lend,
but the person's spending determines how
long that cash lasts. That's why there
isn't a magic number where there
suddenly becomes free money. Now, the
more someone owns relative to what they
borrow and spend, the more room they
have to manage that loan. And the bank
will care whether those $10 million are
spread across investments or tied up in
one company whose shares could fall
sharply. Someone rich enough to get that
loan still has to pay for it. But, where
does the interest money come from? So,
here's an example, okay? Suppose a
person with $10 million in shares
borrows at a 6% interest rate. Their
interest bill is $60,000 a year or
roughly 5,000 a month. They may be
allowed to pay only that interest while
leaving the million-dollar balance
untouched. Owning shares worth 10
million doesn't automatically put 5,000
into their bank account every month. The
shares might pay dividends, which are
cash payments that some companies make
to their shareholders. But suppose those
payments give them $100,000 a year after
tax. [music] They could cover the
interest and still have 40,000 left.
They could even use that 40,000 to
reduce the debt. The interest-only terms
give them a choice about the original
loan amount. [music] They don't forbid
repayment, but many shares pay little or
nothing in cash. The price should rise
all year, making that person richer on
paper, while the interest bill still
arrives on Friday. They might pay it
from a business, from rent on a
property, or savings they already have.
They might even sell a few shares. They
could keep some borrowed money aside to
cover the payments, although that does
leave less of the loan to spend. Or they
could ask the bank for more money to pay
the interest if the loan allows it. That
last option is costly, though, because
borrowing to pay interest increases the
balance. It also creates another
question for anyone who plans to live on
loans for years. If the first million
runs out and they borrow again, the debt
grows with their spending. Someone
spending $200,000 a year can't keep a
million-dollar loan unchanged forever
unless other cash is paying for some of
that lifestyle. There may be a business
funding it, income from investments, or
a plan to sell something later on. For
some people, that later sale is the
whole reason to borrow. Say someone has
agreed to sell a property, but the buyer
won't pay them for another 3 months.
They borrow against their shares to
cover a large expense today, then repay
the bank when the property sale closes.
They've paid 3 months of interest to
solve a 3-month cash problem. But if the
buyer pulls out, they need a different
plan. And that's a very different
arrangement from spending against your
shares for 30 years. Now, before we get
into what happens when that
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but in the meantime, let's get back to
what happens when the million-dollar
loan comes due. All right, suppose
someone reaches the repayment date and
doesn't want to sell their investments.
They can ask the bank to extend the loan
or ask another bank for a new one. If
the second bank approves a million
dollars, that money can pay off the
first bank. The person now owes the
second bank under a new agreement.
That's what refinancing looks like in
cash terms. It keeps the investments in
place and moves the debt to another
agreement. Say that 10 million dollars
in shares have grown to 15 million by
then. A bank looking at the new loan
sees more investments behind the same
million-dollar debt. It might even agree
to lend more, but that's a new decision
for the bank, and a larger loan means
more to repay. What if the shares are
worth 6 million instead? The person
still has assets worth far more than the
debt, so a replacement loan might remain
possible. The bank may lend less, charge
more, or ask for different investments
to back the loan. The old deal doesn't
entitle anyone to the same deal again.
There's also a reason someone might
choose to refinance even when they have
enough shares to sell. Suppose they
bought a block of shares for $100,000
and those shares are now worth a
million. Under US tax rules, selling the
lot can create a $900,000 gain, which
may be taxable. Borrowing against the
shares gives them access to cash without
selling them today. They might decide
that paying interest is worth keeping
the investment and delaying that sale.
If interest gets too expensive, [music]
they can change their mind and sell some
shares to reduce the loan. There's no
promise the investment will grow enough
to justify the cost. So far, everything
has depended on the bank being willing
to continue the arrangement. But what
can make the bank ask for its money now?
Some loans have a scheduled end date,
but some work more like a credit line,
allowing someone to take money, repay
it, and borrow again within a limit.
Certain credit lines also allow the
lender to demand repayment before the
person expected to pay it back. Schwab's
terms, for example, say its bank can
demand some or all a balance at any
time. That's an important detail if
you've already spent the cash. Interest
rates can change, too. [music] On the
million-dollar loan, moving from 6% to
9% adds $30,000 to the yearly interest
bill. Someone whose income covered the
old bill might decide the new one isn't
worth it. The more urgent problem comes
when the investments behind the loan
fall in value. Take a separate example
where someone borrows $800,000 against
shares worth 2 million. Suppose their
agreement requires the loan to remain at
or below half the value of those shares.
The shares fall to $1.2 million.
Well, now the bank will only allow
$600,000 of debt against them, but the
person still owes $800,000. The bank can
ask for $200,000 in cash or more
investments to back the loan. If they
can't provide either, the bank might
sell some of the shares already backing
it. Selling those shares also reduces
what's left to back the bank. In this
simplified example, it would take a
$400,000 sale to pay down the loan
enough to satisfy the half value rule.
They would be left with $400,000 of debt
against $800,000 of shares. [music] The
person might believe the shares will
recover next year, but the bank might
give them only days to act. Someone who
borrowed a million against 10 million in
shares started with more room for prices
to fall. And that's a big part of how
people can keep this going for a long
time. It still doesn't mean the bank has
given the money it can never ask to have
back. [music]
And if the bank never forces a sale,
someone can leave the debt outstanding
for the rest of their life.
So, who pays when the person dies? Well,
the answer here follows US rules because
inheritance rules vary from country to
country. Money and property someone
leaves behind can be used to settle what
they owe. That collection of money and
property is called their estate. The
person handling the estate can use its
cash or sell assets to pay the [music]
bank. Children generally don't have to
pay a parent's loan from their own
savings just because they're the
children, although shared debts and
other exceptions do exist. But, the bank
still has a claim to be paid from the
assets backing its loan. One American
tax rule can change the cost of selling
investments after death. Suppose someone
paid a million dollars for shares that
are worth 10 million when they die. For
many inherited investments, the value
used as the starting point for
calculating a taxable gain becomes their
market value at death. If the usual rule
applies here, that starting value
becomes $10 million.
Sell the shares for 10 million, and
there's no gain above that new starting
value on that sale. But, now suppose the
estate owes a million dollars to the
bank. If the value hasn't changed, it
could sell a million dollars worth of
shares to settle that debt with no
capital gain on that portion under these
assumptions. But the remaining shares
are worth 9 million before other bills,
expenses, and other taxes. So the family
has still given up a million dollars of
investments to pay back the bank. The
tax treatment can make the sale cheaper
than it would have been during the
person's life. Estate taxes and
different kinds of assets can change the
result and any gain after death can be
taxable when the shares are sold. But
the basic sequence is clear. Someone
borrowed money while they were alive,
paid for the loan as they went, and then
kept investments that they wanted to
hold. Later, the remaining debt was paid
with assets [music] they left behind.
The bank got its money, the cost to the
family was interest already paid, and
part of the inheritance used to settle
that bill. All right, that's a wrap for
today, Alexa. We'll see you back here
next time. Until then, take care.