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In today’s investment world, there are many passive income opportunities, but one often-overlooked strategy is fully paid lending. To earn extra income with fully paid lending programs, you can enroll with your broker, who will lend your stocks or ETFs, typically, to short sellers on your behalf. This way, you generate additional income while still maintaining ownership of your assets.
I first learned about this program from a close friend and coworker, who shared his experience using fully paid lending to boost his own investment returns. I’m grateful for the tip and wanted to pass along the benefits to you.
Key Takeaways
- Earn Passive Income: Fully paid lending programs let you earn extra income by lending stocks or ETFs in high demand for short selling.
- Collateral Protection: Brokers provide at least 100% collateral to protect against counterparty risk, held by a third-party bank.
- Flexibility with Selling: You can sell your shares anytime, though there are exceptions.
- Voting and Tax Considerations: Loaning shares forfeits voting rights, and dividends are replaced with “cash-in-lieu” payments that may have different tax implications.
What Is a Fully Paid Lending Program?
In a fully paid lending program, brokers like Fidelity™, E*TRADE™, and Charles Schwab™ borrow your fully paid stocks or ETFs and lend them to other market participants, typically short sellers. Short sellers attempt to profit from a stock’s decline by borrowing shares, selling them at the current price, and later buying them back at a lower price if the stock drops.
Shares that are in high demand for short selling—often because they have limited availability—command higher lending fees. This happens when there is a restricted supply of shares available in the market, either due to strong investor holding or limited circulation. For example, stocks with recent market volatility, insider selling activity, or upcoming negative corporate announcements may become more difficult to borrow as demand for shorting increases.
To participate, you must sign up for the program. Fidelity requires at least $25,000 in each brokerage account you wish to enroll, while E*TRADE has a higher threshold, requiring $200,000 in eligible securities. (It’s unclear to me what Schwab’s minimum requirement is.) Once enrolled, both the broker and the investor retain the right to end the loan at any time.
How Demand Impacts Earnings
Not all shares are in demand for short selling. The higher the demand for a particular stock or ETF, the more you can earn from lending it. Conversely, if there is no demand, your securities may not be borrowed, and thus, you won’t earn any income. This makes fully paid lending programs most lucrative when you hold high-demand securities.
Potential Earnings and Collateral
Income from fully paid lending is calculated based on the interest rate applied to the borrowed shares, which varies with market conditions and demand. A typical example could look like this: Lending $100,000 worth of securities at an annualized rate of 7.5% would yield approximately $625 monthly. However, these rates are variable and may fluctuate based on market conditions.
One important aspect is collateral. Unlike traditional margin loans, where the investor puts up collateral, the broker (e.g., Fidelity or E*TRADE) is responsible for providing collateral, typically at 102-104% of the loan’s value, to mitigate the risk of counterparty default. This collateral is held by an independent third-party bank, and in the event of a default, it acts as your safety net.
Risks and Considerations
While fully paid lending programs offer passive income potential, they also come with several important risks:
- Loss of Voting Rights: When you lend your shares, you forfeit your voting rights on corporate actions. To regain them, you’d need to recall your shares before the record date.
- Tax Implications: Dividends are replaced with “cash-in-lieu” payments if a company declares dividends while your shares are loaned. These substitute payments may not qualify for the favorable capital gains tax treatment that dividends can receive.
- Counterparty Risk: Although brokers provide collateral, shares on loan are not covered by SIPC insurance. This means that if the broker defaults, you are only protected by the collateral, which may fluctuate based on market conditions.
Flexibility with Selling and Covered Calls
One key advantage of fully paid lending programs is the flexibility to sell your shares at any time, even while they are on loan. Fidelity’s program also allows you to sell covered calls against your loaned shares, adding another source of potential income. However, if you have sold covered calls, you may be unable to sell the shares without first buying back the call options.
This layer of flexibility makes fully paid lending an attractive option for investors looking to maximize returns on long-held positions.
To learn more about covered calls, see Options 101: How to Use Call and Put Options to Protect Your Portfolio.
Is Fully Paid Lending Right for You?
Fully paid lending programs can be a great way to earn passive income, especially if you hold high-demand stocks or ETFs. However, these programs are somewhat unconventional, so they may not suit every investor. If voting rights or favorable tax treatment on dividends are important to you, this may not be the best choice. Additionally, the counterparty risk, although mitigated by collateral, remains a consideration.
For those willing to take on these risks, fully paid lending can provide an incremental income stream with little effort. If you’re already holding long-term positions in your portfolio, why not make them work a little harder?
To learn more about fully paid lending programs, check out these brokerage websites:
And remember, it’s always a great idea to chat with your financial or tax advisor to make sure your decisions are right on track and aligned with the latest guidelines and laws.