Borrowing money requires research by the investor to find a suitable match for them. All the factors need to be considered, like repayment terms, interest rate, collateral required, etc. A loan against securities is a good way to issue a loan and meet the demand for money without actually selling the asset. Various banks offer this service at a reasonable interest rate.
But are they suitable for everyone? Do they have any cons? This article will help you understand loan against securities, along with the pros and cons associated with it.
What is a Loan Against Securities?
One kind of secured loan is a Loan Against Securities (LAS), in which a borrower pledges their financial assets, such as stocks, mutual funds, bonds, or insurance policies, as security for the loan. People who want easy access to money for personal expenses, business needs, emergencies, or education, while keeping ownership of their investments, frequently use this credit facility.
It enables investors to satisfy their immediate liquidity requirements without having to sell their long-term assets. The approved loan amount is typically between 50% and 80% of the market value of the pledged securities, depending on the type of security. For example, HDFC Bank approves up to 80% of the total value of the security.
Key Features
- A secured loan that requires the investor to pledge authorized financial instruments as security.
- Funds are released in a day or two if all documentation is in order.
- The (Loan to Value) LTV Ratio is generally between 50% and 80%, depending on the type of security.
- It offers flexible repayment options, like term loans and overdraft facilities.
- Particularly for fintech lenders or digital demat accounts, little paperwork is required.
- The borrower is still entitled to dividends, bonuses, and pledged asset rights as the ownership right is retained.
| Type of Security | Valid For LAS? |
| Listed Equity Shares (Demat) | Yes |
| Mutual Fund Units (Equity/Debt) | Yes |
| Government Bonds & Debentures | Yes |
| Fixed Maturity Plans (FMPs) | Yes |
| Life Insurance Policies (LIC) | Yes (surrender value) |
| ETFs (Exchange Traded Funds) | Yes |
| Unlisted Shares | No |
Pros of Loan Against Securities
- Maintains Ownership of the Investment: It helps you in sanctioning a loan without selling your securities. Capital gains, bonuses, and dividends are received by the borrower as the ownership remains intact.
- Reduced Interest Rates: Since LAS is a secured loan, interest rates are usually lower than those of unsecured loans like credit cards or personal loans.
- No Effect on the Creation of Long-Term Wealth: You don’t lose out on compounding returns or market growth because your investment portfolio is still the same.
- Accessible Overdraft Facility: LAS is available as an overdraft at many banks. Only the amount used is subject to interest; the entire authorised limit is not.
- Fast and Paperless Procedure: The process is quick and easy, frequently with same-day payout, especially when pledging demat shares or mutual funds.
Cons of Loan Against Securities
- Risk of Market Volatility: There is a risk of increasing the value of securities kept as collateral to match the market volatility. In case the initial value of the security declines, the borrower may be required to pay a part of the loan to compensate for it.
- Liquidation Risk: Your pledged investments may be forced to be sold, frequently at a loss, if you are unable to fulfil repayment obligations or margin calls.
- Restricted Loan Amount: The amount of loan that will be issued for a certain security is measured by the LTV ratio. Loan values are lower for high-risk assets.
- Could Interrupt Financial Objectives: If the loan is not properly managed, pledging securities linked to retirement, children’s education, or long-term wealth may result in inadvertent planning gaps.
- Not Every Security Is Accepted: Certain mutual funds, small-cap illiquid stocks, and unlisted shares are examples of instruments that might not qualify.
Is Loan Against Securities Worth It?
It requires discipline and careful planning, then taking out a loan against securities can be a wise financial decision. It provides reduced interest rates, liquidity without liquidation, and the preservation of investment gains. It works particularly well for:
- Owners of businesses require short-term working capital.
- Cash flow mismatches are managed by salaried professionals.
- Since the assets are not sold, the taxable capital gains can be avoided.
It isn’t appropriate, though, for long-term borrowing or for people who can’t handle the risk of market volatility.
Who should opt for LAS?
- You don’t need the money for more than two or three years.
- Your liquid assets are of excellent quality.
- You are able to manage margin pressure and comprehend changes in the market.
Who should not opt for LAS?
- If you are relying on those investments to meet your short-term objectives, it is best not to pledge them.
- Short-term market risk is intolerable.
- Someone with inconsistent income, as your ability to repay is impacted.
Bottomline
The conclusion can be drawn that a loan against securities is a good way of issuing a loan for short-term needs. When comparing with a regular loan, the interest rate is lower. Also, it allows the borrower to earn dividends and interest associated with the securities pledged.
However, it is important that you pay back the loan on time, as the financial institution may force you to sell the pledged security even at a loss to recover the amount. Also, it is advised to cross-check the list of securities that are acceptable. Discipline and consistency of the borrower are important to avail the full benefit of it.
Written by: Tanya Kumari
