There are various types of secured loans available in the market, and you can select the appropriate loan product depending on the size of the fund required, tenure, type of asset available with you to pledge, among others.
There are several loan instruments available in the market and each one of them carries different characteristics and suitability. Now, from the perspective of the requirement to pledge a security against a financing facility, loans can be divided into two categories: unsecured loans and secured or collateralized loans. Both have their own set of advantages.
In this article, I’ll focus on the various types of collateralized loans involving security like gold, shares, fixed deposits, insurance policies, cars, property, etc. to help you make informed financing decisions.
Features and benefits of secured loans
You can get unsecured loans which would eliminate the requirement of having to pledge a security against it, but they usually come at a higher cost. The interest rates and charges on a secured loan could be lesser than an unsecured loan like a personal loan. Pledging security like gold, shares, mutual funds, etc., cushions the lender against the possibility of a default by the borrower. Since the borrower could liquidate the asset to recover his dues, the risk premium on the loan interest reduces significantly.
In a secured loan, the borrower may also have greater flexibility in comparison to an unsecured loan, such as the option of a longer repayment tenure and higher loan amount with lower interest. That being said, the loan amount will be contingent upon the pledged security’s value — the higher the value, the greater the loan you could take against it, and vice versa. Besides, pledging of security in a collateralized loan lowers the dependency on the borrower’s credit score; meaning, if a borrower has a poor credit score, he may not be eligible for an unsecured loan, and even if he does, he’s likely to get a steeper interest rate on the loan; therefore, applying for a secured loan could be a much better financing option for him.
There are various types of secured loans available in the market, and you can select the appropriate loan product depending on the size of the fund required, tenure for which you need the loan, the type of asset available with you to pledge, and the interest rate applicable on it. Let’s check out various secured loans and their features.
1. Gold loan
If you’re going through a cash crunch, you may unlock the value of your gold jewellery or gold coins (with a minimum purity of 18 carats) lying idle in a locker to use it as a collateral to get a loan against it to meet your liquidity requirements. Banks and financial institutions usually allow a loan up to 75% of the prevailing market value of the pledged gold subject to the lender’s loan amount threshold. The interest rates typically range in between 7.5-15% p.a. depending upon the loan amount, tenure and the lender’s policies. While some lenders also charge a processing fee (usually 0.25-1% of the loan amount), others do not charge any such fee. A gold loan could be an attractive option for those who have some gold with them and whose loan requirement is not huge.
2. Loan against securities such as mutual funds/ shares/ bonds/ FDs
You can also get a loan against your investments such as mutual funds, shares, bonds, etc. Usually, banks allow a Loan-to-Value (LTV) ratio of up to 50% where the loan is against market-linked securities such as shares and mutual funds. But the LTV for Kisan Vikas Patra and Non-Convertible Debentures (NCD) is higher at around 80% while it could be 90% for fixed deposits. You can use loans against your long-term investments in shares, mutual funds, and bonds to meet your short-term fund requirement. The interest on loans against securities depends on the type of the underlying securities and the loan amount. For example, in loans against FDs, banks usually charge a spread of 1-2% over and above the interest in the FD offered as collateral.
3. Loan against car
If you are looking for a loan and don’t want to pledge your investments, a loan against your car can be a good option. Banks usually allow an LTV of around 50% of the assessed value of the car but some lenders allow a high LTV of up to 150% of the value of the car. The loan amount depends on the car’s make, model, year of purchase, and condition. The interest on such loans is usually higher than loans against securities or gold. That said, it can still be an excellent instrument for borrowers who don’t have other options to put as collateral.
4. Loan against an insurance policy
If you have a traditional life insurance policy like an endowment plan, you can use it as a collateral to get a loan. Banks consider the paid-up value, and not the sum assured, of the insurance policy for estimating the maximum permissible loan amount to a borrower. Loan against insurance policies suits borrowers who want a long tenure and are looking for a low-interest option. Banks allow an LTV of up to around 90% under a loan against life policy. However, you must maintain a policy for at least 3 years to make it eligible as loan collateral.
5. Loan against property
If your loan requirement is big and you are looking for a very long repayment tenure, loan against property could be a great financing option. Banks usually allow an LTV of 60-65% for such loans and the interest rate is around 7-10% p.a. depending on the loan amount and tenure among other factors.
Critical things to keep in mind before applying for a secured loan
Secured loans are a very attractive borrowing tool provided you select the one that best meets your requirements. For example, if you have a big fund requirement then instead of using many collaterals, you can collateralize a high-value asset like your property or your life insurance plan to get a consolidated loan at a lower rate. Also, avoid collateralizing a high-value asset for a low-value loan. Under loans against securities, the borrower is required to maintain mark to market margin, and failing to do so can trigger a liquidation of collateral by the lender. So, borrowers should avoid high loan amounts on securities such as shares and mutual funds when the market is volatile. Besides, it might be a better idea to liquidate your profitable mutual fund investments to meet your fund requirements instead of pledging them as loan security.
Most importantly, have a thorough repayment plan before applying for any secured loan as any defaults could lead to a loss of a precious asset which could have long-term implications on your family’s financial future, especially if you have pledged something as critical as your life insurance policy, property or household gold to get the loan. Lastly, always compare your options, including pre-approved unsecured loans, and factor in other associated charges like processing fee and pre-payment penalties to get the best loan deal.
(The writer is CEO, BankBazaar.com)