Quick Cash: How to Easily Get a Loan Against Your Shares

November 3, 2024 By: Nisha Chawla

In today’s world, many people are investing in the stock market, not just to grow wealth but also to keep financial options open. If you’re one of those investors and need cash on short notice, you can easily take a loan against your shares. Here’s a breakdown of what it means, how it works, and what to keep in mind.

What is a Loan Against Shares?

A loan against shares (LAS) is a type of loan where your shares act as collateral. Instead of selling your shares when you need cash, you can pledge them to the lender and take a loan. This way, you retain ownership of your shares, allowing you to benefit from any increase in their value, even while they are mortgaged. Banks and mutual fund companies in India offer this facility, often structured as an overdraft.

Key Features of Loans Against Shares

1. Overdraft Facility: LAS loans are often provided as an overdraft. This means there’s no fixed EMI for repaying the principal amount, making it more flexible.
2. No Fixed Repayment: Unlike a personal loan, you don’t need to follow a fixed repayment schedule. You can repay the amount anytime within the loan period, which is usually set for 1 year.
3. Monthly Interest: Interest is charged only on the amount you use from the sanctioned limit. It’s generally deducted from your registered bank account monthly, saving you the hassle of manual payments.

How Much Can You Borrow?

The loan amount depends on the value of shares you pledge and the maximum loan-to-value (LTV) ratio set by the Reserve Bank of India (RBI). The RBI permits a maximum LTV ratio of 50% on such loans, meaning you can borrow up to half the value of the pledged shares.

Example:

• If you pledge shares worth ₹10 lakh, you can get a loan of up to ₹5 lakh.
• For mid-cap or small-cap stocks, the LTV may be lower, sometimes falling to around 30%, depending on the lender’s policies.

Interest Rate for Loan Against Shares

Interest rates for LAS typically range from 9% to 12%, based on the lender’s terms and your credit profile. Here’s a quick example to show how interest on LAS works:

• Let’s say you take a ₹5 lakh loan at a 10% annual interest rate.
• The daily interest rate would be about 0.03%, making the monthly interest around 0.85%.
• So, each month, you’ll pay approximately ₹4,246 as interest on the full loan amount.

Remember, interest is only charged on the amount you use from the total loan limit, making it cost-effective if you don’t use the full loan amount immediately.

What Happens If the Value of Your Shares Drops?

The value of stocks can fluctuate, and a decline in the value of pledged shares can impact your loan.

Scenario:

Imagine you’ve taken an overdraft of ₹5 lakh against shares valued at ₹10 lakh. If the market value of these shares drops to ₹8 lakh, the loan-to-value ratio (LTV) will cross the 50% limit. To correct this, the lender will likely ask you to either:

1. Reduce the Loan Amount: Bring down the loan to around ₹4 lakh to align with the new share value.
2. Pledge More Shares: Add more shares worth around ₹2 lakh as security to maintain the required LTV.

Lenders usually monitor the LTV daily, so be prepared for possible margin calls if the stock market experiences significant dips.

What if You Don’t Pay the Interest on Time?

Timely interest payments are crucial to avoid penalties or even losing your pledged shares. Depending on the lender’s terms, if the interest is not paid for 60 to 90 days from the due date, they may initiate the sale of pledged shares to recover the unpaid amount. This is an important risk to remember—missing payments could mean losing your shares, even if their value appreciates over time.

Pros and Cons of Taking a Loan Against Shares

Pros:

1. Quick Access to Cash: Get funds without liquidating your investments.
2. Flexible Repayment: No rigid monthly EMIs—repay whenever within the tenure.
3. Interest-Only on Amount Used: You only pay interest on the amount you use from the approved loan limit.

Cons:

1. Market Risks: A drop in share prices could force you to repay some loan amount or pledge more shares.
2. Interest Payment Requirement: Missing payments can lead to the sale of your shares.
3. LTV Limit: Limited to 50% of share value, or less for volatile stocks.

When is a Loan Against Shares a Good Idea?

Taking a loan against shares is best suited for urgent or short-term cash needs, especially when selling shares could result in a significant loss or capital gains tax. However, experts advise against using this option unless you have a solid repayment plan, as the risk of losing your shares can be high.