Understanding loan against equity shares
A loan against equity shares, also known as securities-backed lending, is a financial arrangement where borrowers use their equity share investments as collateral to obtain a loan. This type of loan is typically offered by financial institutions, including banks and Non-Banking Financial Companies (NBFCs). The borrower essentially pledges their equity portfolio as a security for the loan, unlocking the value of their investments without having to sell them.
Features & benefits of loan against shares
Loan against shares offers several advantages for investors seeking liquidity while retaining ownership of their investments:
- Collateral-based security: The borrower's equity portfolio serves as a security for the loan, enabling a quick disbursal process.
- Loan-to-value (LTV) ratio: The amount of loan sanctioned is determined by the loan-to-value ratio, which is the percentage of the market value of the equity shares. Typically, lenders offer a percentage of the total value of the equity shares, with the LTV ratio varying among lending institutions. Bajaj Finance Limited offers loan up to 50% of the equity shares’ value.
- Interest rates: Interest rates on loans against equity shares are generally lower compared to unsecured loans. The rates can be fixed or floating, depending on the terms of the loan agreement.
- Flexible repayment options: Borrowers often have the flexibility to choose from various repayment options, such as regular EMIs (equated monthly installments) or interest-only payments with a bullet repayment of principal at the end of the loan tenure.
How does a loan against equity shares work?
The mechanism of a loan against equity shares involves several key steps:
- Application: The borrower applies for the loan by providing details of their equity portfolio and other necessary documents as required by the lender.
- Valuation: The lender evaluates the market value of the equity shares offered as collateral to determine the loan amount that can be sanctioned. The loan-to-value ratio is then applied to calculate the eligible loan amount.
- Documentation: Once the valuation is completed, the borrower and lender enter into a formal agreement outlining the terms and conditions of the loan, including interest rates, tenure, and repayment schedule.
- Pledge of securities: The borrower pledges the equity shares to the lender as security for the loan and gives the lender the right to sell the shares if the borrower defaults under the loan.
- Disbursement: Upon completion of the documentation and pledging of shares, the lender disburses the loan amount to the borrower's account.
- Monitoring and margin calls: Throughout the loan tenure, the lender monitors the market value of the pledged securities. If the value falls below a specified threshold, the borrower receives a margin call, requiring them to provide additional shares for maintaining the LTV ratio.
What to avoid while availing of a loan against equity shares?
While a loan against equity shares can be a useful financial tool, borrowers should exercise caution to avoid potential pitfalls:
- Market volatility: The value of equity shares is subject to market fluctuations. Borrowers should be aware of the risks involved, as a significant drop in the market value of the pledged securities could lead to a margin call or the need for additional collateral.
- Understanding terms and conditions: It is crucial for borrowers to thoroughly understand the terms and conditions of the loan, including interest rates, repayment options, and any associated fees or charges as may be stipulated in the loan documents.
- Regular monitoring of the portfolio: Borrowers should actively monitor their equity portfolio's performance and take the necessary steps to address any margin calls promptly.
Conclusion
A loan against equity shares can be a valuable financial tool for customers seeking funds without liquidating their investment holdings. By understanding the features, mechanism, and potential risks associated with this type of loan, borrowers can make informed decisions to meet their financial needs while safeguarding their investment portfolios. As with any financial instrument, careful consideration, due diligence, and adherence to the terms and conditions of the loan documents are essential to ensure a positive and secure borrowing experience.
