Collateral Security Loan: Meaning, Types, Benefits and Risks

Collateral security is an asset that a borrower pledges to a lender to secure a loan. It provides the lender with a means of recovering outstanding dues if the borrower fails to meet the repayment obligations, subject to the agreement and applicable law.

For example, if you own listed shares and need funds for a business expense, you may be able to pledge eligible shares instead of selling them. The lender assesses the shares and determines the permissible borrowing amount.

Common forms of collateral include:

• Listed shares
• Eligible mutual fund units
• Certain life insurance policies
• Fixed deposits
• Property or other assets accepted by a lender under a separate secured lending product

Not every asset qualifies as collateral for every loan. The lender determines which assets it accepts and the conditions under which they can be pledged.

A loan against collateral security is a secured credit facility in which a borrower pledges an eligible asset to obtain funds. The asset acts as security for the loan, and the borrowing amount is generally linked to its assessed value and the lender's applicable LTV limit.

A Loan Against Securities (LAS) is one category of this borrowing arrangement. Depending on the product, it may allow you to borrow against shares, mutual funds or eligible insurance policies. A loan against a fixed deposit is another secured borrowing option, with its own terms.

For example, suppose you hold eligible shares valued at Rs. 10 lakh. If the lender applies an LTV limit of 50%, the indicative maximum borrowing amount would be Rs. 5 lakh, subject to eligibility and other conditions.

The shares are pledged rather than sold. However, you must meet the repayment and collateral requirements specified in the loan agreement.

The process involves assessing the asset, determining the available borrowing limit, completing the pledge formalities and repaying the loan under the agreed terms:

1. Identify an eligible asset: Check whether the lender accepts your shares, mutual funds, insurance policy or other proposed collateral.
2. Establish the asset's value: The lender assesses the asset using its applicable valuation method.
3. Calculate the borrowing limit: The lender applies the relevant LTV ratio and eligibility conditions.
4. Complete the application: Submit the required identity, address and asset-ownership documents, along with any additional information requested.
5. Pledge the asset: Complete the applicable pledge or lien-marking process, which gives the lender the agreed security rights.
6. Receive the funds: Disbursal takes place after the application, documentation and collateral formalities are completed and approved.
7. Repay the loan: Pay interest and principal according to the repayment schedule or facility terms.
8. Release the collateral: Once the relevant dues and release conditions are satisfied, the lender processes the release of the pledged asset.

The exact steps and timelines depend on the asset, lender and product.

The amount depends on the eligible value of the asset and the applicable LTV ratio. LTV is the proportion of the asset's assessed value that a lender permits you to borrow.

The following examples illustrate how product-specific limits can differ:

The share and mutual fund figures reflect published Bajaj Finance product information. The insurance-policy figure is a product-specific indicative limit and depends on policy eligibility and the applicable terms. These limits are not interchangeable or guaranteed loan amounts.

For a fixed deposit, the borrowing limit depends on the lender's terms and the value of the deposit.

How is the loan amount calculated?

The basic calculation is:

Indicative loan amount = Eligible collateral value × Applicable LTV ratio

For example, if eligible mutual fund units are valued at Rs. 2,00,000 and the applicable LTV is 90%:

Rs. 2,00,000 × 90% = Rs. 1,80,000

The indicative borrowing limit is Rs. 1,80,000. The actual amount may be lower because of the lender's valuation, eligibility rules, existing liabilities or other conditions.

The assets accepted depend on the lender and the specific loan product:

1. Listed shares

A loan against shares allows you to pledge eligible listed shares held in a dematerialised account. The lender assesses the approved shares and their market value to determine the borrowing limit.

Bajaj Finance publishes an LTV of up to 90% for eligible shares. The available limit can change as share prices fluctuate, and borrowers must meet the applicable collateral-maintenance requirements.

2. Mutual funds

Eligible mutual fund units may be pledged to obtain a loan without redeeming them immediately. The accepted schemes and applicable LTV depend on the lender's approved list and product terms.

Bajaj Finance publishes an LTV of up to 90% for eligible mutual funds. This does not mean that every mutual fund scheme qualifies or that every borrower will receive the maximum limit.

3. Insurance policies

Certain insurance policies may be accepted as collateral. The amount available generally depends on the policy's eligibility and surrender value, along with the lender's conditions.

The policy must meet the relevant product requirements. Do not assume that every life insurance policy or ULIP automatically qualifies.

4. Fixed deposits

A loan against a fixed deposit allows an eligible deposit holder to borrow without prematurely closing the deposit. The fixed deposit serves as security for the loan.

The permitted loan amount, interest rate and other conditions depend on the financial institution and deposit terms. This facility should be assessed separately from loans against shares or mutual funds.

5. Other assets

Some lenders accept other types of collateral, such as property or specified financial instruments, under separate lending products. Eligibility, valuation and legal requirements differ by asset type.

A collateral-backed loan can provide access to funds while allowing you to retain eligible assets, subject to the loan agreement:

• Access to liquidity: Borrow against eligible assets to meet planned expenses or funding requirements.

  
  

• Avoid immediate asset sale: You may not need to sell shares or redeem mutual fund units solely to access funds.

  
  

• Potentially lower borrowing costs: Secured credit may have a lower interest rate than some unsecured loans, although actual pricing varies by lender and borrower.

  
  

• Borrowing linked to asset value: The LTV ratio provides a basis for determining the permissible loan amount.

  
  
• Different collateral options: Eligible borrowers may be able to choose between products backed by shares, mutual funds, insurance policies or fixed deposits.

• Potential flexibility in drawing funds: Certain LAS facilities charge interest on the amount utilised rather than the entire sanctioned limit. This depends on the product's terms.

These benefits should be weighed against interest, fees, repayment obligations and the possibility of losing the pledged asset following a default.

A secured loan creates a repayment obligation and exposes the pledged asset to the lender's security rights. Understanding these risks is essential before borrowing:

The value of market-linked assets can fall

Shares and mutual funds can lose value. A decline in the value of pledged assets may reduce the available borrowing limit or cause a shortfall in the required collateral coverage.

Depending on the loan terms, the lender may require additional collateral or partial repayment within a specified period.

The lender may sell pledged assets

If the borrower defaults or fails to resolve a collateral shortfall, the lender may enforce its rights over the pledged assets, including selling them where permitted under the agreement and applicable rules.

This can result in the loss of investments, potentially at an unfavourable market price.

Interest and fees increase the total cost

The borrowing cost may include interest, processing fees and applicable pledge, renewal or other charges. Compare the total cost instead of relying only on the headline interest rate.

Ownership does not remove the lender's rights

You may retain ownership of pledged investments, but the lender has security rights over them. Those rights can restrict your ability to sell, transfer or otherwise deal with the assets while they remain pledged.

Borrowing to invest can increase risk

Using a loan to purchase additional market-linked investments can amplify losses. Investment returns are not guaranteed, while the loan must be repaid under its agreed terms.

A loan against collateral may be worth considering when you have eligible assets and need funds but do not want to sell those assets immediately. Suitability depends on the purpose of borrowing, affordability and the risks associated with the collateral.

Possible situations include:

• Business expenses: A business owner may consider borrowing against eligible investments to meet a short-term funding requirement.
• Education expenses: A borrower may evaluate a secured loan to help meet an education-related payment.
• Planned major expenses: An eligible asset may provide collateral for a large, planned expenditure.
• Temporary cash-flow gaps: A borrower with a clear repayment plan may consider a secured facility to manage a temporary funding requirement.

A loan should not be treated as suitable simply because collateral is available. Assess whether your expected cash flow can cover the interest and principal, including if the value of your pledged investments falls.

A secured loan and an unsecured loan differ in whether the lender receives collateral and how the borrowing amount is assessed.

Neither option is universally better. Compare the interest rate, fees, total repayment amount, processing time, eligibility and consequences of default.

Ready to make your investments work harder for you? Apply for a loan against securities today

Documentation depends on the lender, borrower type and collateral being pledged. Applicants may be asked to provide:

• Proof of identity and address, such as an accepted official document
• PAN or other applicable tax identification details
• A demat holding statement for shares or relevant investment holdings
• Mutual fund or insurance policy details, where applicable
• Bank account details
• A completed application and any additional declarations or documents required by the lender

Some documents may be verified digitally. The exact requirements should be confirmed against the selected product's current application instructions.

A collateral security loan allows eligible borrowers to obtain funds by pledging an asset instead of necessarily selling it. The borrowing limit depends on the collateral's value, the applicable LTV ratio and the lender's eligibility conditions.

Shares, mutual funds, eligible insurance policies and fixed deposits can be used under different secured lending products, but their terms are not interchangeable. Before applying, compare interest rates, fees, repayment conditions and the risks of a collateral shortfall. Make sure you can repay the loan without relying on uncertain investment returns.