How to take a loan against securities

Podcast Duration: 05:24

Before virtual school happened, my niece once brought home an entirely black and white sketch of a rainbow over a field of sunflowers. I asked her about the logic behind the lack of colour and she said she'd forgotten to take her crayons and paints with her that day. "Wouldn't anyone let you borrow their paints or colors?" I asked her and she said: "Yes but they wanted paint or crayons in exchange."

"Why would you need any if you had your own?" I asked her.

"Exactly!" she said to me.

My niece's debacle made me think of the many people who grumble at banks about the fact that if they had collateral to offer, they would not need the loan in the first place. But did you know that you can use your shares as collateral for a loan? In other words, you could get a loan against shares held by you.

Let's begin with the basics: what exactly is a loan against securities?

A loan against securities is a loan that is given to the applicant against stock market listed securities such as bonds, mutual funds and shares. In this way your stock market investments act as the collateral required for your loan to be approved.

You may opt for a loan against securities for various purposes whether it is some sort of emergency or personal requirement. Different providers might have different product offerings and restrictions but overall you can get a home loan, an education loan, an auto loan. You may even opt for a loan if you want to take new positions without selling your existing positions. In other words, maybe you want to continue holding the shares you have in hand until a more opportune moment to sell comes along. But you have also zeroed in on some additional opportunities. You may go ahead and apply for a loan against stock that you are already holding. Check that your loan allows for this before applying

You can get a loan against securities from most banks and from several non banking finance corporations. The applicant does need to specify the purpose of the loan and there may be amount restrictions for loans that intended to be used for either stock market investment. As with all financial transactions and paperwork, read the offer document carefully before putting your name on the dotted line.

The interest payable on your loan against shares is variable. Most providers will order an interest calculator as part of the application process.

Online application for such loans is a fairly standard process among providers. One usually needs to log in to their net banking or just needs to log in to their Broking app. Thereafter the applicant needs to identify shares to be put up as collateral. The agreement is "inked" virtually usually by use of an OTP sent to the user's registered email or mobile number. Applicants usually need to supply the expected set of documents for proof of identity and address, bank account, and income.

Loan applicants are best advised to keep in mind the following considerations;

For loan against shares specifically, the applicant needs to have a demat account because the loan is given against shares held and in order to hold shares one needs a demat account.

The word securities might be a little ambiguous for some. To elaborate, a loan may be obtained against any of the following:

Equity or shares
Gold Deposit Certificates
Insurance policies
Mutual funds
National Savings Certificates
Non Convertible Debentures

Interest rates vary between providers. You can expect an average of a little under 7% to over 10%.

The amount you may be eligible to also varies among banks and NFBCs but you could expect to get a loan amount that is about 50% to 80% of your holdings according to published literature by providers.

The amount of margins that need to be parked by the trader will be specified by the bank or NBFC offering the loan. It might hover around 50% of the ongoing market prices of the shares.

Also check about intricacies such as foreclosure rates and monthly interest rates. Some providers might offer to charge interest only on the loan amount used.

Banks and NBFCs will scan loan applicants before agreeing to give them a loan and loan applicants should similarly scan providers before they zero in on a chosen bank or NBFC. Compare interest rates, foreclosure rates, fees and processing charges, the amount you will be eligible to and processing time for issuing the loan between several trustworthy names before choosing one.

In case you are opting for a loan in order to fund further stock market investment, be certain that your loan agreement allows for this. In all cases but especially so with borrowed funds - remember that the stock market is a dynamic environment. Invest cautiously especially with borrowed funds - adopt a low risk strategy as you need to ensure that you will not default on your loan. Remember than loan defaults affect your credit score and the ability for you to obtain a loan in the future.