Loan against shares: How it works
A loan against shares is a secured loan where an investor pledges their equity shares of listed companies to obtain financing. The lender assesses the current market price, liquidity, and volatility of the shares before determining the eligible loan amount. Since stock markets are inherently unpredictable, lenders impose lower LTV ratios to safeguard their exposure.
The interest rate on loans against shares depends on the lender and the borrower’s creditworthiness. These loans are generally structured as overdraft facilities, where interest is charged only on the amount utilised. However, if the market value of pledged shares falls significantly, lenders may issue margin calls, requiring the borrower to provide additional collateral or repay part of the loan.
Loans against shares are commonly used for short-term liquidity needs, business expansion, or personal financing without selling off investments. However, due to stock market fluctuations, borrowers must monitor their pledged securities closely to avoid potential forced liquidation by lenders.
Mutual funds: A different money game
A loan against mutual funds works similarly to a loan against shares, but instead of pledging individual stocks, borrowers use their mutual fund units as collateral. Lenders evaluate the fund type, Net Asset Value (NAV), and risk profile before approving the loan. Debt mutual funds generally attract higher LTV ratios than equity mutual funds due to their lower market volatility.
Mutual funds provide a more stable form of collateral, making loans against them less susceptible to margin calls compared to loans against shares. Borrowers continue earning returns on their investments while accessing liquidity without redemption. This makes loans against mutual funds a preferred choice for investors who seek capital while preserving long-term investment growth.
Interest rates on loans against mutual funds are typically lower than unsecured loans, but they depend on factors such as the borrower's creditworthiness and the lender’s policies. These loans are particularly beneficial for business owners, investors, and individuals looking for flexible financing without disturbing their long-term financial goals.
Loan against shares vs. mutual funds: What's the difference?
While both loans against shares and mutual funds serve as effective financing tools, they differ in risk exposure, loan eligibility, and flexibility. The primary distinction lies in the volatility of the collateral. Shares are prone to significant price fluctuations, making loans against them riskier. Mutual funds, particularly debt funds, are comparatively stable, reducing the chances of margin calls.
Another key difference is the loan-to-value ratio (LTV). Loans against mutual funds generally offer a higher LTV than loans against shares due to the diversified nature of mutual fund portfolios. This means borrowers can secure a higher loan amount against mutual funds than against individual stocks of the same market value.
Additionally, mutual funds allow investors to avoid the risk of forced liquidation due to stock price drops, whereas a decline in share prices can trigger immediate lender intervention. Investors seeking less market-sensitive financing often prefer mutual fund-backed loans.
While both options provide financial flexibility, the choice depends on the borrower's risk tolerance, investment type, and liquidity needs.
Deciding which is right for you
Choosing between a loan against shares and a loan against mutual funds depends on several factors, including financial goals, investment type, and risk appetite.
A loan against shares is best suited for:
Borrowers who need short-term liquidity and are confident about market stability.
Investors willing to manage market fluctuations and potential margin calls.
Individuals looking to leverage highly liquid stocks for quick access to funds.
A loan against mutual funds is more suitable for:
Borrowers seeking a stable collateral-backed loan with minimal risk of margin calls.
Investors looking for a higher LTV ratio and flexible repayment options.
Those who want liquidity while ensuring their mutual fund investments continue growing.
Borrowers should carefully evaluate their financial position, repayment capability, and market conditions before deciding which loan type suits them best.
Conclusion
Both loans against shares and loans against mutual funds provide an efficient way to access liquidity while retaining investment ownership. However, the choice between the two depends on risk appetite, investment type, and financial goals.
A loan against shares offers quick access to funds but carries higher risks due to stock price volatility. On the other hand, a loan against mutual funds provides a more stable financing option with lower chances of forced liquidation. Investors must assess their needs and choose the loan option that aligns with their financial strategy, ensuring both liquidity and portfolio security.Top of FormBottom of Form
