Loan against shares is a financial product that allows investors to leverage their stock holdings to meet their liquidity needs. By pledging their shares as collateral, investors can access funds without having to sell their stocks, thereby retaining ownership and potential future gains. This article explores the concept of loans against shares, the types of stocks approved for such loans, and the benefits and risks associated with this financial instrument.
Types of stocks approved for loan
Type of Stocks/Assets |
Description |
Details |
Blue-chip stocks |
Blue-chip stocks are shares of large, well-established companies with a history of stable earnings and strong financials. |
Lenders often prefer blue-chip stocks as collateral due to their stability and liquidity in the market. These stocks are less volatile and are considered safer bets for lenders. |
Mid-cap stocks |
Mid-cap stocks are shares of companies with a market capitalisation between that of large-cap and small-cap companies. |
While mid-cap stocks are more volatile than blue-chip stocks, they can still be approved for loans against shares. Lenders may require a higher margin or interest rate for such stocks. |
Large-cap stocks |
Large-cap stocks are shares of companies with a market capitalisation typically exceeding Rs. 20,000 crore |
Large-cap stocks are considered relatively safe investments, making them suitable for loans against shares. Lenders may offer favorable terms for loans backed by large-cap stocks. |
Exchange Traded Funds (ETFs) |
ETFs are investment funds that are traded on stock exchanges, similar to stocks. |
Some lenders may accept ETFs as collateral for loans against shares. ETFs offer diversification benefits, making them attractive to lenders. |
Mutual fund units |
Mutual fund units represent ownership in a mutual fund, which pools money from investors to invest in stocks, bonds, or other securities. |
Some lenders may accept mutual fund units as collateral for loans against shares. However, the loan amount may be limited to a certain percentage of the mutual fund's net asset value. |
How do loans against stocks work?
- Pledge stocks: Borrowers pledge their stocks or shares as collateral to a lender.
- Loan amount: The lender assesses the value of the pledged stocks and offers a loan amount based on a certain percentage of the stock's value.
- Loan terms: Borrowers agree to the loan terms, including the interest rate, repayment schedule, and any other conditions set by the lender.
- Disbursement of funds: Once the loan agreement is signed, the lender disburses the loan amount to the borrower.
- Ownership retained: Borrowers retain ownership of the pledged stocks and continue to receive any dividends or other benefits associated with the stocks.
- Interest payments: Borrowers are required to make regular interest payments on the loan amount.
- Margin requirements: Lenders may require borrowers to maintain a certain margin, which is the minimum value of the pledged stocks relative to the loan amount.
- Potential margin calls: If the value of the pledged stocks falls below the required margin, borrowers may be required to provide additional collateral or repay part of the loan to maintain the margin.
- Repayment: Borrowers repay the loan amount according to the agreed-upon schedule, which may include both principal and interest payments.
- Release of pledged stocks: Once the loan is fully repaid, the lender releases the pledged stocks back to the borrower.
Benefits of loan against stocks
- Liquidity: Investors can access funds without selling their stocks, allowing them to meet their short-term liquidity needs.
- Retain ownership: Investors retain ownership of their stocks, which means they can benefit from any future appreciation in stock prices.
- Lower interest rates: Loan against shares typically offers lower interest rates compared to unsecured loans, as the stocks serve as collateral.
Things to consider before availing loan against stocks
- Loan amount: Consider the amount you need and ensure it aligns with the value of the stocks you plan to pledge. Lenders typically offer a loan amount based on a percentage of the stock's current market value.
- Interest rates: Compare interest rates offered by different lenders. Lower interest rates can help reduce the cost of the loan.
- Loan-to-Value (LTV) ratio: Understand the LTV ratio offered by the lender, which determines the maximum loan amount you can avail of based on the value of the pledged stocks. A higher LTV ratio can help you access more funds but may increase the risk of margin calls.
- Margin calls: Be aware of the possibility of margin calls if the value of the pledged stocks falls below a certain level. Ensure you have a plan in place to meet margin requirements to avoid potential consequences.
- Repayment terms: Review the repayment terms, including the tenure and schedule of repayments. Ensure you can comfortably manage the repayment schedule along with your other financial obligations.
- Impact on stock portfolio: Consider the impact of pledging stocks on your overall stock portfolio. Pledging too many stocks may limit your ability to make changes to your portfolio or take advantage of market opportunities.
- Risk assessment: Assess the risks associated with a loan against stocks, including the potential loss of pledged stocks if you are unable to repay the loan. Consider alternative financing options if the risks outweigh the benefits.
- Tax implications: Understand the tax implications of availing a loan against stocks. Interest paid on the loan may be tax-deductible, but the sale of pledged stocks may incur capital gains tax.
- Alternative financing options: Explore alternative financing options, such as personal loans or lines of credit, to compare terms and choose the best option for your financial needs.
- Financial advisor consultation: Consider consulting with a financial advisor to assess your financial situation and determine if availing a loan against stocks is the right choice for you. A financial advisor can help you weigh the pros and cons and make an informed decision based on your circumstances.
Conclusion
Loan against shares is a useful financial tool that allows investors to unlock the value of their stock holdings without having to sell them. By pledging their stocks as collateral, investors can access funds for various purposes while retaining ownership of their stocks. However, it is important for investors to carefully consider the risks involved, such as margin calls and potential loss of collateral, before opting for a loan against shares.
