What Is a Nonpurpose Loan?

A nonpurpose loan is an extension of credit that allows borrowers to pledge securities as collateral to access funds for personal reasons. Borrowers, for example, can use a nonpurpose loan to finance real estate transactions and education expenses.

Borrowers cannot use nonpurpose loans to buy, trade, or carry margin stock. Federal regulators define margin stock to include equity, debt, and investment-company-issued securities.

Obtaining a collateralized bank loan in excess of $100,000 secured directly or indirectly by margin stock requires you to complete a form stating the purpose of the loan. This article highlights the similarities and differences between a purpose loan and a nonpurpose loan.

Key Points

• Nonpurpose loans allow investors to access cash without selling assets.

• You can’t use the funds to purchase, trade, or carry margin stock, as nonpurpose loans are restricted to noninvestment uses under federal rules.

• Collateral risk and market volatility are critical factors to consider.

• Federal Reserve Regulation U requires specific documentation for certain loans.

• A securities-backed line of credit (SBLOC) typically features lower interest rates than unsecured lending products.

How Do Nonpurpose Loans Work?

For nonpurpose loans, lenders provide borrowers with an extension of credit using investment securities as collateral. Stockholders, for example, can pledge eligible equity securities as collateral to obtain these loans.

Under Regulation U, the Federal Reserve Board of Governors typically requires that borrowers disclose the specific purpose of a nonpurpose loan. You can use nonpurpose loans from banks or nonbank lenders for almost any purpose except buying or carrying margin stock.

Investors, for example, can take out nonpurpose loans to help finance real estate transactions or cover unforeseen expenses.

Example of a Nonpurpose Loan

An SBLOC is an example of a nonpurpose loan. SBLOCs allow investors to use eligible securities in their investment portfolios as collateral to secure a line of credit. You can use SBLOCs for a wide variety of purposes except buying, carrying, or trading margin stock.

Investors commonly obtain SBLOCs through brokerage firms. These nonpurpose loans can carry risky terms and conditions for borrowers.

Securities-based loan providers may require borrowers to meet and maintain sufficient collateral requirements. If the pledged collateral value drops below a set level, for example, lenders may require borrowers to deposit additional funds or eligible securities.

Purpose vs Nonpurpose Loan: Similarities and Differences

A purpose loan is an extension of credit for buying or carrying margin stock. A nonpurpose loan, meanwhile, is an extension of credit you can use for any purpose other than buying or carrying margin stock.

Nonpurpose loans use margin stock as collateral, and purpose loans are often secured by similar types of collateral.

Which Is Better?

A purpose loan isn’t necessarily better than a nonpurpose loan, and nonpurpose loans aren’t necessarily better than purpose loans. Both options can present risks to the borrower. 

Investors who can’t tolerate the risk of pledging securities as collateral may prefer an unsecured purpose loan over nonpurpose loans. Other investors who want access to quick capital without liquidating their security holdings may view nonpurpose loans more favorably.

Borrowers have several alternatives to consider, including personal loans. Personal loans ranging from $1,000 to $100,000 are generally available through banks, credit unions, and private lenders.

There are multiple benefits of obtaining a personal loan, such as the following:

• Borrowers can get an unsecured personal loan with no collateral.

• Expecting mothers can use personal loans as a maternity leave loan.

• The borrower’s personal discretion determines the purpose of a personal loan.

Personal loans come with distinct advantages and disadvantages. For example, they can help you build credit but may feature high rates of interest.

Personal loans can provide a lump sum of cash that you must repay over a set period. Defaulting on a personal loan can have a major impact on your credit score.

Borrowing money to buy securities is possible, but it is typically done through margin accounts, and some lenders may restrict using personal loans for this purpose. 

Pros and Cons of Nonpurpose Loans

The following table highlights some of the pros and cons of nonpurpose loans:

The Pros of Nonpurpose Loans

Below are some of the pros of nonpurpose loans:

Flexibility

Nonpurpose loans give borrowers the flexibility to spend the funds on almost anything other than buying or carrying margin stock. Borrowers generally receive quick approval and can use nonpurpose credit to finance a dream vacation or home repairs, among other things. 

Interest

Borrowers can get relatively low interest rates on nonpurpose loans. These loans may save the borrower hundreds, or thousands of dollars in financing costs.

Securities as Collateral

Investors with a well-diversified investment portfolio may pledge eligible securities as collateral for large sums of financing. This can give investors quick access to capital without liquidating their security holdings.

Cons of Nonpurpose Loans

Below are some of the cons of nonpurpose loans: 

Volatility

Volatility in the equity markets can impact borrowers of nonpurpose loans. The value of stocks and other securities in your investment portfolio can fluctuate. Lenders of nonpurpose loans may require you to deposit additional funds or eligible securities if the value of your pledged collateral falls significantly.

Additional Collateral

To reiterate, lenders of nonpurpose loans may require you to deposit additional cash or securities if the market value of your pledged collateral drops below the required threshold. This is an inherent risk of nonpurpose loans.

Restricted Funds

Nonpurpose loans restrict the borrower from using the funds to buy, carry, or trade additional securities. You may have to consider other options if you need to borrow money to buy stocks or bonds.

Alternatives for Nonpurpose Loans

Here are some alternatives to nonpurpose loans:

Credit Cards

Credit cards are an alternative to nonpurpose loans. Every credit card account has a predetermined credit limit, capping how much you can charge on the card. 

Cardholders repay their credit card debts over time and can make monthly payments that meet or exceed the minimum payment due. You can generally avoid paying interest on credit card purchases by paying your statement balance in full each billing cycle.

Recommended: How to Read a Credit Card Statement

Personal Loans

Personal loans are an alternative to nonpurpose loans. There are at least eight types of personal loans that consumers may consider, depending on their needs.

Personal loans ranging from $1,000 to $100,000 are commonly available from various lenders. Your credit score and debt-to-income ratio may impact how much of a personal loan you can get   from a lender.

The Takeaway

Nonpurpose loans can present a number of risks to the borrower. These collateralized loans may provide you with quick financing, but lenders can sell your pledged securities if you fail to meet collateral maintenance requirements. Investors may consider other borrowing options.

Lantern by SoFi can help you check the current personal loan rates. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process of applying for a personal loan with the lender of your choice. Check your rate today and see if you prequalify.