When you require short-term liquidity but do not want to sell your long-term investments, a Loan Against Shares (LAS) can be a considerable option. This loan enables one to leverage their holdings as security while retaining their ownership. It is a form of secured credit facility that can be beneficial to meet short-term financial requirements without the pressure of having to disturb one’s investment portfolio. This article discusses the working mechanisms of a loan against shares and what you can expect in terms of interest rates for this loan.
What is a Loan Against Shares?
A loan against shares (LAS) is a facility where lenders offer you a credit by holding your listed shares as collateral. To avail this loan, you do not have to sell your shares. The shares remain in your Demat account, however, will be marked as pledged. The lender approves a loan amount based on a percentage of the prevailing market value of shares.
This kind of loan is usually applied for:
- Managing cash flow for short-term needs
- Managing medical or school bills
- Support business needs without selling assets.
However, you should note that this facility works only when the value of shares pledged remains stable or appreciates.
How Does a Loan Against Shares Work?
Here’s how loan against shares work:
- Eligibility Verification: The lenders have a list of approved shares, and only these shares can be used as collateral. The borrowers must also fulfil minimum income or Know Your Customer requirements.
- Application and Pledge: The procedure is initiated by the lender. The stocks are pledged on behalf of the lender upon sanction. The procedure is done electronically through the dematerialised (Demat) account.
- Loan Disbursement: Depending on the share value, a loan value (typically 50–60% of the share’s market value) is credited to your account.
- Utilisation and Reimbursements: The loan can be granted as a line of credit or as a lump sum, depending on how the lender structures it. The interest is charged on the amount borrowed or drawn.
- De-Pledge of Shares: On repayment of the loan, the shares will be de-pledged and returned to the borrower.
This method is swift, and in certain cases, it can be completed online on the lender’s website.
Factors to Keep in Mind
Factors you should consider before applying for a loan against shares include:
- Loan to Value Ratio (LTV): The maximum loan amount you can get is usually a percentage of the share’s value and depends on current market conditions.
- Loan Term: Tenures can be from a few months to three years. Some lenders may offer renewals.
- Monitoring the Pledged Share: If the share prices decline substantially, the lender can request additional securities or part repayment of the loan in order to be able to hold the margin required.
- Ownership Held: During the period of commitment, one continues to receive dividends and retains voting rights.
This specific type of credit is useful if one wants liquidity but at the same time wants to retain their long-term investment goals.
Loan Against Securities Interest Rates
Loan against securities interest rates may be favourable compared to unsecured loan rates of interest. However, they also differ with the lender, type, and borrower profile. The following factors influence the loan against securities rates of interest:
- Lender Type: Some lenders may offer affordable rates of interest compared to banks.
- Borrower’s Credit Profile: An efficient payment record and credit history can result in favourable terms.
- Loan Amount and Tenure: Variation in the rates may be caused by higher loan amount or tenures.
- Nature of Shares Pledged: Blue-chip stocks with stable prices may result in affordable interest compared to volatile or low-volume stocks.
Lenders can also charge annual maintenance fees or processing fees, which you should factor in when you choose a lender.
The Pros and Cons of Getting a Loan Against Shares
Let us understand the benefits of this type of loan along with the possible risks.
Potential Benefits:
- Easy access to capital without having to sell investments
- Affordable interest rates than unsecured loans
- Continued ownership and dividend payment for shares pledged
Potential Risks:
- Market volatility can affect the value of shares pledged, leading to margin calls.
- Relying on pledged shares can affect your long-term investment objectives
- If payment is not fulfilled, lenders may sell pledged shares on notice.
Therefore, the borrowers must utilise this facility with appropriate budgeting.
Conclusion
Understanding how a loan against shares works helps you in making informed borrowing decisions when you have a short-term capital requirement. It provides both liquidity and the ability to retain the ownership of your investments. However, before applying for a loan against shares, you must consider the interest rate, associated risks, and your capacity to repay before opting for it. Planning ahead can help you maintain control over your short-term needs as well as your long-term investments.
