With consumer spending on rise and loans getting expensive, individuals are finding new ways to fulfill their money requirements. Providing Loans against Gold etc. is one more way in which borrowers are able to procure loans from banks. Yet another way to procure a loan is through LAS (loan against security). A loan against shares would fall under this category. This option is not known to many borrowers as banks do not advertise this often. The loan is granted when you pledge your shares to the bank. More and more banks are offering this option now and also expanding the financial assets that can be used as for a LAS option.
How does this work?
You cannot get a loan against all shares. Banks usually define the shares of the companies which can be pledged against the loan. These shares are very liquid, from high quality companies, and highly valued securities. The amount depends on valuation of shares, margin allowed by the bank, and your past credit history. The amount of loan is about 50% to 70% of the value of the shares pledged with the bank. Hence if your stock portfolio for these shares is 10 lakhs, you can get a loan of 5 lakhs to 7 lakhs against the stock portfolio. This again depends on the liquidity of the stocks in your portfolio.
You can pledge your shares with the bank, which will issue a current account. You can withdraw money from this account. The advantage of loan against shares is that you will be charged interest only on the amount you withdraw from the account and for the span of time the fund is utilized. The other advantage is that you require no personal guarantor for loan against shares.
Banks keep changing the shares against which loans can be taken. This happens at regular intervals. This is done to ensure the stability and liquidity of shares which can be pledged.
If you have shares in the physical form, most of the banks require that you convert them into dematerialized form and then only you can apply for a loan. Dematerializing physical shares is not difficult. Few banks may provide loan against shares in physical form too. However, the interest rate will be higher and also the loan amount as a percentage of the value of the share will be lower.
When should you go for it?
You should opt for loan against shares only when you need instant liquidity and you are sure to pay it back in few months. If you have any doubt on your repayment capability, try other sources.
The interest rate on loan against share depends on the prevailing rate in the market. You should compare the interest rate for loan against shares with other options such as a personal loan or need specific loan. If you find a cheaper option, go for that.
Many borrowers take loan against shares to invest it back in shares. Don't do this. Taking a loan to buy shares is a financially harmful habit. In fact many banks attach the clause that you cannot use it for buying shares.
Important points to keep in mind
Getting a loan against share is hassle free and the borrower is mostly free to spend the money in a manner he or she wishes to. This comes with no strings attached. You should have good and valued shares in your portfolio to get a loan against it. However, you must keep some factors in mind when you opt for this.
The minimum amount of a loan against shares is 1 lakh while the maximum amount is 20 lakhs. You can get the loan for a year and renew it in future. The tenure may vary with individual banks. The maximum amount in the case of physical shares is 10 lakhs.
Don't be tempted to borrow just because you have a good portfolio. You have built this portfolio over a period of time with due diligence. Unless absolutely necessary, don't pledge your shares to obtain a loan. If you do pledge to get a loan against the stock portfolio, make sure that you pay it back at the first opportunity.
Look at the various charges such as processing fees, one-time fee, renewal charges, Government levies, and service taxes. Usually there is no pre-payment penalty but it is advisable to ensure this with the bank. These charges may make the actual cost of loan higher than the interest rate charged.
Shares are valued every week to see the maximum limit of loan available to you. As long as the market is bullish, you will have no problem. In fact if the share prices go up, the banks will be able to give you a higher amount of loan. However, when the value of your portfolio falls, banks ask you to pay the difference using cash or by pledging more shares. This could be potentially dangerous if you do not have any cash available with you or any more shares. Banks may sell your stocks to recover the loan, if circumstances demand so.
The dividends, bonuses, or any benefit on the pledged shares will accrue to you.
On loan against other financial assets
Banks also provide loan against other financial assets such as mutual funds, insurance, bonds, fixed maturity plans, exchange traded funds, and Government securities. The total loan value against the pledged assets varies with individual cases. The value is higher, almost 80% of the asset value, for Government securities as these are risk free assets.