In the realm of personal and business finance, securing a loan against securities can be a practical way to access funds without liquidating your investments. Loans against securities are secured loans where your financial assets act as collateral. Understanding the different types of loans available can help you choose the option that best fits your needs. In this article, we’ll explore the various types of loans against securities, using real-life examples to illustrate each type, and answer some frequently asked questions.
1. Loan Against Shares
Overview: A Loan Against Shares allows you to borrow money by pledging your shares or equity investments as collateral. The loan amount is typically a percentage of the market value of the shares.
Example: Suppose Priya holds shares worth ₹10,00,000 in a prominent company. She needs ₹3,00,000 for a personal emergency and opts for a Loan Against Shares. Based on the lender’s policy, she might be able to borrow up to 50% of the shares’ value, which translates to ₹5,00,000 in this case. She decides to borrow ₹3,00,000, and the shares are held as collateral until the loan is repaid. Since it works like an overdraft, her limit of Rs.5 lacs allows her to borrow another Rs.2 lacs anytime she wants. She would be charged interest only on the amount she utilises.
Pros:
- Lower interest rates compared to unsecured loans.
- Quick access to funds.
- Pay interest only on the funds used.
Cons:
- The value of shares can fluctuate, affecting the collateral.
- Risk of losing shares if the loan is not repaid.
2. Loan Against Mutual Funds
Overview: This type of loan involves pledging your mutual fund units as collateral. You can borrow a percentage of the mutual fund’s current market value.
Example: Ankit has mutual funds worth ₹5,00,000 and needs ₹1,50,000 for a home renovation. He takes a Loan Against Mutual Funds at an interest rate of 10.5%. The lender agrees to provide a loan based on 50% of the mutual fund’s value, so Ankit gets ₹1,50,000 with his mutual funds as collateral.
Pros:
- Generally lower interest rates due to collateral.
- Allows you to access funds without selling your investments.
- In case of Debt Mutual Funds schemes, one can borrow up to 80% of value.
Cons:
- If mutual fund values drop, you may need to pledge additional securities or repay part of the loan.
3. Loan Against Bonds
Overview: Bonds, whether government or corporate, can be used as collateral for a loan. The loan amount is usually a percentage of the bond’s face value or market value.
Example: Ramesh holds corporate bonds worth ₹7,00,000. He needs ₹2,00,000 to fund his business expansion. By pledging his bonds, he secures a loan of ₹2,00,000. The lender assesses the bonds’ value and provides the loan against them.
Pros:
- Lower risk for the lender, resulting in better loan terms.
- Stable interest rates due to predictable bond yields.
- Higher loan-to-value ratio as compared to equity and equity related products.
Cons:
- Bonds must be in good standing and not approaching maturity.
4. Loan Against Fixed Deposits (FDs)
Overview: Fixed Deposits can be used as collateral for a loan. The loan amount is typically a percentage of the FD’s value, minus any applicable penalties or charges.
Example: Seema has an FD of ₹4,00,000 with a bank. She needs ₹1,00,000 urgently and decides to take a Loan Against FD. The bank allows her to borrow up to 90% of the FD’s value, so she gets ₹1,00,000 while the FD continues to earn interest.
Pros:
- Usually offers the lowest interest rates compared to other secured loans.
- The FD continues to earn interest during the loan tenure.
- If the facility is used in the same bank, the process is simple and quick.
Cons:
- The loan amount is limited to a percentage of the FD value.
- Prepayment penalties might apply if you repay the loan early.
5. Loan Against Insurance Policies
Overview: Some insurance policies, particularly those with a cash value component, can be used as collateral for a loan. The loan amount is based on the policy’s surrender value.
Example: Vikram has a life insurance policy with a surrender value of ₹3,00,000. He needs ₹1,00,000 for medical expenses and opts for a loan against his insurance policy. The lender evaluates the policy’s value and provides the loan accordingly. Similar to pledge in case of Shares, bonds or mutual funds, in case of insurance policies a process of Assignment takes place.
Pros:
- Generally lower interest rates compared to unsecured loans.
- The insurance policy remains active even while securing the loan.
Cons:
- The loan amount is often limited to a percentage of the policy’s surrender value.
Check Out – Top 5 Myths About Loans Against Mutual Funds
Frequently Asked Questions (FAQs)
1. What are the common factors that lenders consider when offering loans against securities?
Lenders typically consider the type of security (shares, bonds, mutual funds), its market value, liquidity, the borrower’s creditworthiness, and the loan-to-value ratio. They also assess the stability and liquidity of the collateral.
2. Can I use more than one type of security as collateral for a single loan?
Yes, many lenders allow you to pledge multiple types of securities as collateral for a single loan. This can enhance your borrowing capacity and provide more flexibility.
3. What happens if the value of my collateral decreases after taking the loan?
If the value of your collateral decreases significantly, the lender may request additional collateral or repayment to maintain the loan-to-value ratio. It’s essential to monitor the value of your securities and communicate with your lender if there are significant changes.
4. Are there any tax implications for taking a loan against securities?
Typically, the interest paid on loans against securities is not eligible for tax deductions. However, tax implications might vary based on the type of security and the nature of the loan. Consult a tax advisor for specific guidance.
5. Can I repay my loan against securities early?
Most lenders allow early repayment of loans against securities, but some may charge prepayment penalties or fees. Check the terms of your loan agreement for details on prepayment options and any associated charges. With Neoble, you will not have to pay any prepayment penalty or foreclosure fees on LAMF products.
6. How does the loan approval process for loans against securities work?
The loan approval process involves assessing the value of the pledged securities, verifying ownership, and evaluating your creditworthiness. The lender will also determine the loan amount based on the loan-to-value ratio and the type of securities. Needless to say, KYC is an integral part of the loan process.
Conclusion
Loans against securities offer a flexible and often cost-effective way to access funds without liquidating your investments. By understanding the various types of loans available—such as those against shares, mutual funds, bonds, fixed deposits, and insurance policies—you can make an informed decision based on your financial needs and the value of your assets.
If you have any further questions or experiences to share about loans against securities, feel free to leave a comment below. An informed approach can help you make the most of your financial assets while managing your borrowing needs effectively.
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