Why taking loan against securities makes sense during rising stock markets

Loan against securities allows investors to raise funds by leveraging their existing investments. During the loan tenure, the borrower continues to receive the credit of interest, dividends, bonuses etc. on the pledged securities. This loan facility serves as an excellent option for long-term investors. They can meet their short-term fund shortfalls without jeopardizing their long term financial goals.

Here are six crucial features of loan against securities to be aware of before applying for it.

No restriction on end-usage of funds

Loan against securities does not involve any restriction on the end-usage of funds, except for speculative purposes. The loan proceeds can be used towards various purposes, including financing children's higher education, purchasing a vehicle or for meeting other short-term cash flow mismatches. This feature makes loan against securities a good alternative to personal loans, and loans against credit cards.

Offered as overdraft facility

Now, a loan against securities is generally offered as an overdraft facility with a sanctioned credit limit as per the pledged securities. Under this facility, the borrower is free to take the entire sanctioned limit or a part of it as per his fund requirements. Borrowers also have the choice of drawing from the sanctioned limit and repaying it any number of times, till the expiry of the overdraft facility. The interest component is charged on the drawn amount until its repayment.

Also read: Feeling cash strapped? Here are 4 secured loan options that come at low rates

Periodic revaluation of pledged securities

Given that market-linked securities witness price volatility, lenders tend to periodically revalue pledged securities. Lenders may also conduct interim revaluation of the securities in the course of market correction. If steep market corrections lead the total drawn amount to exceed the sanctioned credit limit, then the borrower would have to make good the difference amount by either pledging more securities or paying the difference amount in cash or cheque. Remember that failure to do so may attract penal interest of as high as 18 percent a year on the amount drawn in excess of the sanctioned limit.

List of approved securities and their LTV ratios can vary

Most banks and NBFCs tend to have an approved list of mutual fund schemes, bonds, shares, etc., that could be pledged as collateral for loan against securities. The LTV (loan to value) ratios of these securities also differ according to their asset class, subject to the applicable regulatory cap on LTV ratios assigned by the RBI for each asset class. For instance, lenders generally offer up to 60 percent of the market value of the equity mutual funds used as collateral whereas the regulatory cap on LTV ratios for equities is 75 percent.

It is important to note that the list of the approved individual securities and their respective LTV ratios would also vary across lenders depending on the risk assessment of individual securities. Hence, make sure you find out whether your investments are included in the approved securities list, along with the LTV ratios assigned to them. 

Also read: How to mark a lien on your mutual fund units while taking a loan

Flexible repayment with no prepayment charges

Being an overdraft facility, those taking loans against securities are generally required to service the interest component every month. The principal component can be repaid till the tenure of the overdraft facility, as per the borrower’s cash flows, without incurring any prepayment charges. Hence, the absence of an EMI burden, coupled with no prepayment charges, provides higher flexibility to borrowers in terms of managing their debt obligations as per their cash flows. These flexibilities in repayment make loan against securities an excellent credit option for those facing frequent short-term cash flow mismatches.

Credit-score agnostic

Credit score is one of the first filters factored in by lenders to assess the creditworthiness of borrowers, especially in the case of unsecured personal loans. However, the presence of pledged securities and involvement of lower LTV ratios in loan against securities provides back-up to lenders in case of any default or delayed payment from the borrower. This allows lenders to adopt a relatively relaxed approach towards credit scores while evaluating the applications for loan against securities.