The dos and donts of loan against shares

Written by Adhil Shetty | Updated: Nov 29 2011, 07:29am hrs
With consumer spending on the rise and loans getting expensive, people are finding new ways to fulfil their money requirements. While loan against gold is increasingly becoming a popular means to raise funds, loan against security (LAS) is also an alternative that can be considered.

A loan against shares would fall under the LAS category. Not many borrowers know about this option as banks seldom advertise it. The loan is granted when you pledge your shares to the bank. More and more banks are offering this option now. They are also expanding the list of financial assets that can be used for an LAS option.

How it works

You cannot get a loan against all shares. Banks usually define the shares of the companies that can be pledged against a loan. These shares are very liquid, from high-quality companies and highly valued securities. The amount depends on the valuation of the shares, the margin allowed by the bank and your credit history. The loan amount is about 50-70% of the value of the shares pledged with the bank. Hence, if your stock portfolio for these shares is R10 lakh, you can get a loan of R5-7 lakh against it. This again depends on the liquidity of the stocks in your portfolio. You can pledge your shares with the bank which will issue you 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 time the fund is utilised. Another advantage is that you don't require any personal guarantor for such a loan.

Banks keep changing the shares against which loans can be taken, at regular intervals. This is done to ensure the stability and liquidity of shares that can be pledged. If you have shares in physical form, most banks require that you convert them into a dematerialised form and, then only, can you apply for a loan. Dematerialising physical shares is not difficult. A few banks may provide loan against shares in the 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 to 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 a need-specific loan. If you find a cheaper option, go for that.

Many borrowers take loan against shares to invest it back in shares. This is not advisable. 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.

Things to note

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. In other words, the loan comes with no strings attached. The minimum amount of a loan against shares is R1 lakh, while the maximum is R20 lakh. You can get the loan for a year and renew it later. The tenure may vary with individual banks. The maximum amount in the case of physical shares is R10 lakh.

Unless absolutely necessary, dont 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 confirm this with the bank.

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 or any more shares available with you. 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.

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 in individual cases. The value is higher -- almost 80% of the asset value -- for government securities as these are risk-free assets.