Loan against securities is a good option, but repay as quickly as possible

There are many times you have to raise cash in an emergency. Some of the instruments that can help do so include loans against shares, mutual funds, fixed-maturity plans, exchange-traded funds, insurance policies, government bonds, saving bonds, non-convertible debentures and National Savings Certificates. Typically called loans against securities (LAS), most banks and other lenders give this option to borrowers. “If you are looking for an easy loan, then LAS is a very good option. Instead of liquidating your asset to arrange money during a financial emergency, you can use a qualified investment product to raise a loan at an attractive interest rate. The processing fee on LAS is usually lower compared to personal loan. So, if you want to borrow money with a low-interest rate, need prepayment flexibility, have collateral ready for the pledge, then LAS should be your preferred choice,” says Adhil Shetty, CEO, Bankbazaar.com.

Adds Naveen Kukreja, CEO & Co-founder, Paisabazaar.com says LAS provide quick liquidity along with flexibility for the borrower. “This facility allows borrowers to receive credit of dividends, bonuses, etc during the period of the pledge. Loan against securities also does not come with any end-usage restriction of the loan proceeds, except for speculative purposes.”

Attractive interest rates: The interest rate on loan against securities varies from bank to bank and could vary anywhere between 9-1 per cent. In contrast, the interest rate on personal loans could be in the range of 14-22 per cent or even more. The interest rate could be based on the type of securities pledged and the credit score of the borrower. “Usually, lenders require borrowers just to service the interest cost each month. The principal component can be repaid as per the convenience of the borrower without incurring prepayment/foreclosure charges. Thus, the absence of equated monthly instalments and prepayment charges allows higher flexibility in repayment to the borrowers,” says Kukreja. However, there could be other charges,s such as processing charge, overdraft maintenance fee, stamp duty on the loan agreement, pledge creation fee, de-pledge fee, annual maintenance charges, etc.

Loan-to-value (LTV) ratio: Depending on the security, the lender decides the LTV. So, for a fixed deposit, the bank may lend up to 90 per cent of the value. But it could be much lower, especially in case of a stock. “For instance, if you have applied for a loan against securities by pledging qualified equity product, then the bank usually allows loan up to 50-60 per cent of its market value. So, while looking for LAS, try to pledge the appropriate asset to get maximum loan amount by pledging minimum collateral,” Shetty points out.

Borrower-agnostic: Since the loan is backed by security, lenders are usually comfortable to extend credit to individuals with low credit score or irregular income, if they are in possession of good security. “LAS proves to be even more attractive in a situation when the borrower has no past borrowing record, or when he/she is falling short of credit score requirement,” Shetty says. Also, the time taken to borrow could be less than one day against your securities, especially when they are held in demat form.

Borrower beware: While LAS is a great option to avail a loan, there is a catch. Since the security is pledged, if the borrower fails to repay, the lender has the right to invoke and sell the security the moment the amount outstanding reaches closer to the value of the underlying asset. In such situations, the borrower might be required to offer more security as collateral. This can happen, especially in the case of stocks. 

Thus, if you are availing of LAS, don’t go overboard and limit yourself to the amount you need. Also, since banks don’t charge any prepayment penalty on LAS, whenever you have adequate funds in hand, clear the outstanding loan to save on the interest cost.