Wealth Lending

Using Financial Leverage Strategically

By Ryan E. Berry, BB&T Wealth Division Loan Production and Operations Manager

Within the realm of personal finance, few topics evoke such strong reactions as debt and the use of debt to optimize one’s personal finances. Many experts say having some debt is "good," while others say it’s to be avoided altogether. There are books, television shows, seminars and personal finance programs touting the views of both camps, and it’s hard to find anyone who doesn’t have an opinion on the subject.

When thinking of debt strategically, it's best to view the tool as a financial lever. When deployed effectively, financial leverage can greatly enhance monetary returns.

We can all point to that person who was able to further their education through the use of student loans or the family that was able to purchase their first home (or their dream home) using a mortgage. You can probably think of, or even relate to, the business owner who was able to expand her business, provide good paying jobs and ultimately thrive because of capital provided from a loan. But chances are you can also think of people, families and businesses that have been financially ruined because of their debt obligations. The reality is, just like any other resource, debt can be used wisely and it can be used inappropriately. Debt is simply a tool, and like any tool, it's how one employs it that determines whether the outcome is "good" or "bad".

When thinking of debt strategically, it's best to view the tool as a financial lever. When deployed effectively, financial leverage can greatly enhance monetary returns. When used unsuccessfully, it has the power to dissolve prosperity. In either case, leverage always magnifies results.

Most of us begin forming our beliefs and opinions regarding money long before we realize it, and for many people this begins even before they have much of it. Maybe it was a relative who raised a family during the Great Depression and would frequently share her view on the importance of saving money and living frugally, or maybe it was the uncle who appeared to spend every dollar he made on "toys," yet he always seemed happy and was fun to be around.

We may not have realized it at the time, but the lessons we learned and the experiences we amassed throughout our early years would later combine with our own goals and financial resources to create our individual risk profile. That risk profile essentially says, "Here is the financial strategy that I'm comfortable implementing."

None of us should underestimate the importance of following our individual risk profile, nor can we rely on our neighbor to define it for us. When our financial decisions are in alignment with our risk profile then we have taken the first step toward reaching our goals while also limiting undue stress.

There is a good chance that your willingness to utilize financial leverage correlates to your overall willingness to take financial risks. The person who is heavily weighted in equities tends to be more willing to employ financial leverage in their personal capital structure than the individual who is most interested in fixed income. Any honest discussion regarding the potential benefits and pitfalls of debt must first start with the admission that for each person, family, business and organization the "right" capital structure (mix of equity and debt) will vary depending on the unique goals and underlying risk profile of those involved.

Rather than liquidating part of his holdings to help finance a side project that [the Wealth client] wants to undertake with a friend, he instead uses the portfolio to secure a low-cost Wealth Secured Line of Credit from BB&T.

Leveraging Strength
A lever is one of the earliest tools invented by humans and it was designed to magnify or amplify human strength. A person with a lever can move something much larger and heavier than a person relying on brute strength alone. Having access to capital (debt or equity) is like having access to financial levers. The fact that affluent investors tend to have access to lower-cost borrowing than ordinary investors means they have an even greater opportunity for enhanced financial returns. In many cases, if an investor can earn a return on an investment greater than their cost to borrow, then using financial leverage can be a sound financial decision.

Take, for example, the Wealth client who has put his cash into an investment portfolio that fits his risk profile and is projected to have long-term appreciation. Rather than liquidating part of his holdings to help finance a side project that he wants to undertake with a friend, he instead uses the portfolio to secure a low-cost Wealth Secured Line of Credit from BB&T. This decision not only allows him to diversify his overall investment portfolio but it also provides him with the opportunity to gain substantially higher returns using the same dollars invested. Put another way, he's used leverage to magnify the potential returns of his investment portfolio. The client's risk profile allowed him to be comfortable with the "risk versus return" of his upcoming project. He is confident that while there are risks, his expected return on the new investment should far exceed the interest expense that will be incurred on the line of credit. While he could liquidate a portion of his investments and realign the remaining portfolio, of concern to the client is the tax liability that liquidating investments will create.

Further, because of the client's extensive relationship with BB&T he is receiving a very low interest rate, and the actual cost to implement such a tool is negligible. He's been advised to speak with his tax professional but there are also potential tax benefits that he could receive by using the line of credit attached to his investment portfolio. For this particular individual, he's comfortable with the potential risks, and monetarily it makes sense for him to use leverage to magnify his returns.

The client intends to pay interest-only monthly for the first year. His goal is for the anticipated income from his new project to begin paying back the principal on the line beginning in year two; however, neither the client nor the bank is relying on that potential stream of cash flow as the final source for repayment. Rather, the Wealth Advisor worked to fully understand the client and was able to underwrite and structure the line of credit based on the client's other streams of income.

Example One - Final Structure
Investments at BB&T Wealth
(diversified account)
$2,000,000
(left fully intact)
Approved for a line of up to 75% of
account value
$1,500,000
(large availability, low potential cost)
Client's new investment project $300,000
(expected return >50% over 5 years)
Line availability for future liquidity needs $1,200,000
(no liquidation of portfolio needed)

Let's look at a second example, this time focusing on restructuring existing debt to better align with a client's goals and risk profile. In this example, the client is a surgeon by trade and has been practicing for approximately 11 years. She makes about $400,000 per year, has $575,000 in non-retirement investments, a home valued at $800,000 with a mortgage of $380,000 at 5.25% and remaining student loans of $110,000 at 5.5% (her student loans were taken out with a 30-year amortization). She also has a car loan paid down to $26,000, which carries an interest rate of 4.5%. Further, due to her income level, she isn't able to receive any tax benefit from her student loan interest expense.

After meeting with her Advisor and CPA, along with completing a Wealth Financial Plan, the client realized that she could be more strategic in her use of leverage, but she also wanted to keep her investments intact because of how they align with her long-term financial goals.

She elects to refinance the home and combine the student debt with the mortgage debt for a new mortgage of $490,000. Both of her former loans (mortgage and student debt) now carry a lower effective interest rate. Due to her excess monthly cash flow, risk profile and other long-term goals, she elects to take a 15-year amortization and lock in a historically low mortgage rate.

She agrees with her Advisor and puts a home equity line of credit for $100,000 in place, and she transfers the car loan to this line of credit, which gives her a much lower interest expense as well as additional payment flexibility.

All of her debt (mortgage, student and car) is now potentially tax-deductible, whereas the student and car loan interest expenses were not deductible prior to the debt restructure.

Because she intends to let her investments grow and since there is no cost of origination, she elects to put a $430,000 line of credit in place secured by her investment portfolio. While she doesn't foresee the need to use it in the near term, the credit facility provides instant access to a large amount of liquidity, giving her additional peace of mind. Should she utilize the line, it too has low borrowing costs and potential tax advantages, which she would want to discuss with her tax professional.

As these examples portray, the use of sound and strategic credit was levered as part of the overall wealth accumulation plan for the clients. This process aligned the clients' financial goals with the advisory expertise of a Wealth Advisor to lay out a defined strategic plan for achieving financial success.

If you have questions or would like additional information related to wealth credit or other BB&T services, please contact your Advisor directly.

(All examples given are intended for illustration purposes only and represent neither an offer for credit nor do they imply the terms an applicant would receive upon approval. All credit offers are subject to Bank underwriting and credit approval.)

Ryan E. BerryRyan Berry is the BB&T Wealth Division Loan Production and Operations Manager. He leads a team of High Net Worth Lenders who partner with Wealth Advisors throughout BB&T's footprint to bring strategic credit solutions to clients. A graduate of Virginia Tech, he earned a BS in Finance with a focus in Risk Management.


This article originally appeared in the Spring 2012 issue of Wealth magazine.

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