5 reasons why you should not take loan against shares

By: | Published: December 5, 2015 11:10 AM

If any investor is looking to raise money by pledging his shares, it may not prove to be a lucrative and profitable option.

loan against sharesIf any investor is looking to raise money by pledging his shares, it may not prove to be a lucrative and profitable option. (Reuters)

If any investor is looking to raise money by pledging his shares, it may not prove to be a lucrative and profitable option. According to market experts, most of the banks don’t lend more than 50 per cent of the value of the security as a loan amount. Also, interest and other charges like loan processing, interest in delayed payment is quite high.

Vijay Singhania, founder, director, Trade Smart Online, said, “We generally advise individuals to refrain from seeking loan against shares, unless he knows the specific purpose for which such loans are availed. Leveraging, usually, is not a healthy practice unless there is certainty in the individual’s repayment ability. Further this funding should be limited to high volume front stocks only.”

With the help of market experts we have listed five reasons why an investor should not take a loan against shares:

Loan less than 50 per cent

Most of the banks don’t lend more than 50 per cent of the value of the security as a loan amount. Thus if you are looking at a loan of Rs 3 lakh you will have to pledge shares worth Rs 6 lakh. Also 50 per cent mark is an approximate number, the total amount sanctioned could be less than the limit mentioned.

Anil Rego, chief executive officer and founder, Right Horizons, said, “Usually bankers do have a certain pre-approved list of stocks or basket of stocks, however if your portfolio has stocks which are not within the basket of stocks preferred by the bankers then either the loan may be rejected or those stocks may not be considered for the purpose of loan and hence the percentage of loan approved may be less.”

A Costly Affair

Interest rate on loan against shares and other charges like loan processing, interest in delayed payment is quite high. Rego said, “In some cases interest rates levied on the delayed payment can be as high as 24 per cent per annum i.e. 2 per cent per month. Thus, considering high charges and lower disbursement of loan amount with respect to percentage of the stock value, one should also check the interest rates levied on personal loan.”

The stock price fluctuate and hence the eligible loan amount too fluctuate. For example, at the end of a week if stock markets fall and the outstanding loan amount is higher than the eligible loan amount (revised eligible amount after fall in prices) then the borrower needs to settle the difference.

Take for instance, eligible loan amount is Rs 5 lakh (50 per cent of the portfolio holdings) and if the market falls by 10 per cent; it will make the net portfolio holdings value at Rs 9 lakh and the eligible loan amount would be Rs 4.5 lakh. If the investor has already borrowed Rs 5 lakh then the difference of Rs 50,000 needs to be settled.

Singhania said, “While in a rising market this may seem like an appropriate strategy, in a declining or volatile market, any fall in the price of the shares pledged merits additional margin payment from the individual to maintain the loan-to-value..”

Against multiple scrips

Most of the bankers lend money against multiple stocks/scrips except a few. This is in order to diversify the risk arising out of high concentration in one nor two particular company. So, if you wish to take a loan against shares and you hold shares of only one or two company, it is advised to apply with those bankers who disburse loan on a portfolio comprising of a few stocks. Thus, in order to get ones loan approved (for loan against shares), one must consider following factors before applying;

· The portfolio should comprise of multiple scrips

· The quality of stocks should be good (company financial per se)

· Major holdings should be in large cap companies as midcaps face risk of high market volatility

For lending, banks prefer physical properties than stocks

Usually while granting a loan against an asset, loan against physical property (i.e. Real Estate) is highly preferred as compared to granting a loan against shares. In case of loan against shares the maximum limit would be 50 per cent of the value of the shares, whereas in case of real estate the maximum loan amount could be as high as 65 per cent of the property value. This is because the value of property always appreciates and doesn’t experience high fluctuations or volatility as the prices of shares.

Other Challenges

Though bankers lend money against shares but considering the risk and volatility in the stock market they are not so keen on lending against shares. “If the portfolio has higher allocation towards Mid & Small cap stocks (Higher Risk and Volatility) the percentage of loan approved could be less, said Rego.

The calculation of interest amount is done on regular basis since market witness daily fluctuation – thus this may also have an impact on the interest amount paid. Loan is issued against shares which are in dematerialised form

Few stockbrokers have NBFC subsidiaries who even lend at a lower rates, however this privilege of lower interest rate is limited only to big premium clients as the brokerage earned compensates for lower interest charged.

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