When in need of financial assistance, getting a loan against your shares and securities can provide a quick and efficient way to obtain the required funds. A loan against your shares and securities means that you pledge your stocks as collateral to avail a loan amount from the lender. This loan can be used for a wide range of purposes, from meeting personal expenses to funding a startup or expanding your business. However, before you decide to take out a loan against your shares and securities, there are certain essential factors that you must consider to ensure that you secure the loan safely.
Here are a few things to keep in mind when taking out a loan against shares
Types of securities accepted for pledging
Different lenders may have varying policies and criteria for the types of securities they accept as collateral against a loan. Generally, liquid securities such as stocks, mutual funds, bonds and exchange-traded funds (ETFs) are accepted. Non-convertible debentures (NCDs), fixed deposits (FDs), and life insurance policies can also be pledged in certain cases.
Loan to value (LTV) ratio
LTV ratio is the percentage of the current market value of the shares pledged, against which the lender offers the loan. Typically, lenders offer up to 50-70% LTV. The LTV can vary depending on the type of shares pledged, prevailing market conditions, and the lending institution’s internal policy.
The loan against shares usually have a relatively shorter repayment tenure compared to other secured loans like home loans. So, it is necessary to choose a tenure that is comfortable and easy to manage, keeping in mind the potential returns of the pledged shares after the loan has been repaid.
Interest rates and other charges
As with any loan, the interest rate and other charges can make a significant difference in the total cost of borrowing. The loan against shares interest rate may be higher than regular personal loans, as they are considered to be riskier. Other charges may include processing fees, documentation charges, inspection fees, and pre-payment charges. It is essential to compare the rates and charges offered by different lenders before choosing the most suitable option.
Risks and drawbacks
While the loan against shares can be a valuable financial tool, it does come with inherent risks and drawbacks. One of the most significant risks is the possibility of a prolonged market downturn that can lead to the shares plunging in value, resulting in a margin call by the lender. If the shares pledged fall below the LTV ratio set by the lender, they may be sold off to recover the outstanding loan amount. Moreover, if the borrower defaults on the repayments, the lender may liquidate the securities to recover the amount, resulting in an irreversible loss of investments.
How to Secure the Loan Against Shares and Securities?
To minimize the risks and ensure the safe securing of a loan against shares and securities, here are a few tips to follow:
Choose a reputed and trustworthy lender
It is essential to opt for a lender with a strong track record of customer service, transparent policies, and fair practices. You may consider seeking recommendations from friends, colleagues, or financial advisors before finalizing a lender. It is also prudent to check the lender’s reputation and reviews online and offline to ensure credibility.
Analyze the market
Before pledging your securities, it is crucial to analyze the market trends and the shares’ performance to avoid the risk of incurring losses. Taking assistance from experienced financial advisors or brokers may be beneficial in this regard.
Maintain adequate margin
Maintaining adequate margin over and above the LTV ratio can help mitigate the risk of a margin call and possible forced liquidation of shares. Keeping a cushion of at least 10-20% can also help the borrower retain some control over the pledged securities while securing the loan.
Refrain from over-leveraging
Over-leveraging or taking out a loan that exceeds your means can increase the risk of default and subsequent loss of securities. It is essential to assess your repayment capacity realistically and only avail the loan amount that you can comfortably repay in the prescribed tenure.
A loan against shares and securities is a viable option to obtain quick funds when needed. However, it is crucial to conduct comprehensive due diligence and seek professional advice before opting for this loan type. By staying vigilant and following the guidelines mentioned above, borrowers can secure a loan against shares and securities safely, without risking their investments or future financial stability.