Baby Steps to Becoming Your Own Bank
Three concepts across equity comp, real estate & digital assets
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Good morning, this is Thinking Capital. A weekly mission for you to optimize your financial life. Today’s mission: Becoming your own bank.
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It’s never been easier to become your bank. An odd concept for many of us who grew up with the marble-columned institutions of yesteryear. Equally odd, considering 55M Americans and ~1.7B humans globally are unbanked. Not necessarily of their own volition, but perhaps by their circumstances, income, migrant status or other factors.
The three concepts we’ll discuss today may not directly solve the binary problem of being banked or unbanked for the 1.7B people referenced above, but it does show technological and social progress since these self-sovereign banking primitives are now that much more accessible. Actions that used to require meeting with a banker or branch manager are now deployed with code. Code is not only more equitable, judging our actions instead of our demographics, but also more scalable, meaning micro-loans that wouldn’t be worth a bankers time can be handled by code, allowing more access.
What do I mean by “becoming your own bank”?
Answers to this concept fall on a simple to extreme spectrum, where some folks have rejected the entire traditional finance system and others, like myself, are more interested in borrowing against my assets. You’ve seen these headlines before:
Articles like the above from Protocol may be correct, but the titles are misleading. While there is some financial wizardry involved, these primitives are becoming more accessible.
Concept 1: Borrowing against equity compensation
From Protocol:
“Taking out loans collateralized against stock compensation was one of the most significant tax loopholes exposed by ProPublica. It's common practice for tech CEOs and founders to earn most of their money through stock compensation rather than salary: Steve Jobs, Larry Ellison, and Larry Page have all taken $1 salaries to minimize income tax. But the new IRS documents show how tech billionaires can take it a step further — by taking out a personal loan collateralized against owed stock compensation, tech billionaires avoid tax altogether rather than having to pay the capital gains rate.
The unaccessible aspect is having the billion dollars worth of future equity compensation, but we can pull inspiration from this concept in two ways. If we work for a later-stage or publicly-traded company, many brokerages will issue loans against existing and/or future equity comp. Further, the more nascent robo-advisors, like Wealthfront allow for personal lines of credit, where you can borrow against your portfolio.
🤯 Why borrow, instead of selling?
Taxes — selling typically involves a taxable event, whereas borrowing against your assets is usually tax favorable
Exposure — if your property or equity has appreciated and you believe it will continue to appreciate, than why would you want to sell
Ease — the loan process sucks, and in the case of real estate, a loan from yourself is typically presented as a “cash offer,” giving you negotiation leverage
Concept 2: Borrowing against real estate equity
Instead of a net new mortgage for property, you may want to consider one of the various ways to unlock equity from properties:
Cash-out refinance
HELOC (home equity line of credit)
Home equity loan
Each have pros/cons, but all accomplish the same goal of creating liquidity from a less liquid asset. If I’m buying a fixer-upper with cash, I may want to buy it, renovate it, and then rent it out. Once that process is complete, I can cash-out refinance it which ideally pays back the cash I initially put out plus some bonus to cover or exceed the renovation expenses.
The cash-out refinance process may cost a few thousand dollars and take a month or so to complete, so if the property doesn’t justify that expense, a HELOC may be more appropriate. HELOCs are generally simpler, quicker and cheaper. Almost like a credit card that’s backed by your home. While there aren’t as many fees to initiate them, I’ve typically seen higher interest rates to pay them back.
The last thing to consider is what you’re using the money for. If you plan on funneling money from one rental property to another, the interest rates are slightly less important since they may be tax deductible. More info here.
Concept 3: Borrowing against digital assets
A colleague of mine recently shared how they achieved a 0% APY loan by using their digital assets (crypto) as collateral. For the uninitiated that likely sounds too good to be true, let me explain:
Crypto loans are over-collateralized, meaning for every X you want to borrow, you need to deposit X+Y. In this case, my colleague deposited 2.5x the amount they wanted to borrow: $250 in —> $100 out
What about price fluctuations? Exactly, this is why the loans are over-collateralized. This is also why only certain assets are accepted as collateral.
What happens if the price drops below the collateral minimum? This depends on who you’re borrowing from. Like physical banks, these digital lending portals each have their own set of rules. Unlike physical banks, anyone can borrow any amount for any reason, as long as that person has the collateral to back up their loan.
🤯 Wild right? Digital assets allow anyone with internet access and some collateral can now tap into self-sovereign lending. We may not have the scale of Jeff Bezos, but we’re getting more and more of the tools.
To learn more about decentralized lending I highly recommend this video.
What started as a quick issue, ended up being a beast.
How have you served as your own bank? Let me know and I’ll share your story in a future issue.
<3
Armand