In today’s quick-paced era of finance, money is a reality for investors having good shares but needing cash in hand at the moment. A very preferable solution in such a scenario is a loan against shares. With this equity-based financial instrument, the investor can use his holding of equity in a manner that he can get ready cash without having to dispose of the investment. For the investors from India who wish to get the maximum value out of their portfolio by holding on to the stocks for the long term, it is crucial that they know the mechanism of working of the loan against stock and the rate of interest on a loan against stock.

Read on for an article that talks about the mechanics, advantages, and how to watch out when taking a loan against stocks. The article describes how this form of financing is used to finance your financing needs without having an impact on your share in the market.

What is a loan against stocks

A stock loan is a secured stock loan where lenders have provided their stocks as collateral to banks or non-banking finance companies (NBFCs) in exchange for cash. Rather than selling stocks and forfeiting future returns, shareholders can raise capital by pledging such stocks on a short-term basis.

The amount lent is typically a proportion of market value of shares pledged, or simply the loan-to-value (LVR) ratio. The rate of interest depends on type of shares, level of market volatility, and lender’s policy.

Procedure for loan against shares in India

Lending of shares is one of the popular sources of funds in India, both by retail as well as by portfolio investors. Following is the step-by-step procedure:

1. Selecting shares

You choose the shares on which you want to pledge. These are shares of popular blue-chip, big, mainstream companies with a consistent performance in the market.

2. Employing the loan

You approach a bank or an NBFC that lends against shares and produce the papers you possess, i.e., share certificates or demat records.

3. Margin and share valuation

The lender calculates the market value of shares and determines the LTV ratio, typically ranging from 50% to 70%.

4. Disbursement of loan

According to the approved LTV, the lender credits your bank account with the approved loan amount.

5. Interest and repayment

Amount of loan repayment is paid as interest at loan against stock interest rate. Principal repayment is done according to the duration of the loan.

6. Release of shares pledged

During repayment of your loan, the pledged shares are released to you without charge.

It is much less complicated than the unsecured loan due to the collateral backing.

Loan against stocks benefits

Stock borrowing also has some advantages for which it is greatly preferred by individuals seeking instant money without losing their investment. The advantages are:

Maintain equity and ownership of future dividends

You do not sell shares through stock loans. You are still a shareholder, you receive dividends, and gain from any possible increase in capital. This is most critical during the times of the bull run.

Quicker processing with lower documentation

Since the loan is backed by shares, the lender might request fewer documents than is the case in secured lending. Approval and release could be within a few working days.

Flexible payment schedules

Maximum of the financiers provide flexible repayment tenor and periods, and hence you may select plans according to your cash cycle. You can repay in EMI mode or in bullet payment in which interest paid from time to time and principal paid at maturity.

Competitive rate of interest on loan against stock

Stock loan interest rates are usually lower than unsecured personal loans because the risk for the lender is reduced by collateral. The interest rate on a stock loan is between 9% to 13% annually depending on the lender, market performance, and borrower credit report.

Allows meeting urgent financial needs

In case you have business, medical, educational, or investment opportunity requirements and need finance, borrowing against stocks is an instant finance solution without compromising your equity shares.

Determinants of loan against stock interest rate

This interest rate aspect is something to be noted in advance before applying for this loan. Loan against stock interest rate vary based on a number of factors:

• Type of lender: Banks offer lower interest rates than NBFCs but with greater eligibility.
• Quality of pledge of stocks: Promoter shares or liquid big-cap stocks receive a lower interest than illiquid or mid-cap stocks.
• Size of tenor and size of loan: Large tenor or large-size loans are expected to command a small amount of more interest depending on credit risk and market risk.
• Borrower risk profile: The credit history and repayment behavior record decide the rate of interest to offer.
• Interest rates vary based on macro variables and RBI policy rates.

It is useful for realizing this while negotiating good terms and good repayment dates.

Borrowing against shares versus selling shares: What investors need to know

Investors are said to consider the alternative between borrowing against shares or selling shares in order to address financial requirements. Borrowing against shares has the special advantage, but there are various problems to watch out for:

• Market timing: Selling shares can turn profits into losses or vice versa based on timing in the marketplace. Borrowing on stocks does not permit this to occur.
• Cost of borrowing: Although loans come with interest charges, it is possible these may be lower than the opportunity cost of missing out on future earnings on the stock.
• Loan-to-value limit: You do not get 100% loan value of the stocks; therefore, you can only obtain part of the worth of your investment.
• Margin calls: When the market value of the pledged shares drops below a certain level, lenders can call for extra collateral or repayment of part of the loan.
• Default risk: Default payment would force the lender to sell your collateralized shares under pressure.

So, this lending channel is best suited for people who trust their shares and can return the loans at the appropriate moment.

Documents required for loan against shares in India

It is easy to avail loan against shares but some documents are required to verify identity, ownership, and credit history. These would normally be:

• PAN card (compulsory)
• Aadhaar card or any appropriate address proof
• Demat account statement or share certificates to establish shares held
• Proof of income (salary vouchers, IT returns, bank statements)
• Passport size photographs
• Application for loan and appropriate statements

Accurate and precise documents expedite the loan processing.

Repayment term and loan tenure against shares

Loan tenure against shares is adjustable between 3 months to 3 years. Repayment can be different with lenders, i.e.:

• EMI repayment: Monthly equal payment of interest and principal.
• Interest only repayment: Payment of interest periodically, and principal in lump at loan maturity.
• Bullet repayment: Both principal and interest paid at term end.

Opting for the repayment pattern according to your cash flow calendar is necessary.

Risk involved in taking loan against stocks

Although convenient, loans against stocks too carry risks:

• Market risk: Stock prices rise and fall and impact the loan LTV ratio, leading to margin calls.
• Liquidity risk: Pledged shares are not transferable and saleable prior to loan redemption, decreasing portfolio mobility.
• Default risk: Failure to pay can lead to a compulsory sale of the pledged shares by the financier at distressed prices.
• Fluctuation in interest rate: With floating interest rates, your payment obligation may rise.

Adequate treatment and prudent planning could reduce these issues.

How to select the optimal financier for stock against loan

The perfect financier is the key to hassle-free lending. Adhere to the following:

• Clear disclosure of rate of interest on stock against loan
• Maximum interest rates and lending limits
• Quick processing and hassle-free documentation
• Repayment flexibility to an extent of options and tenures
• Grievance redressal and customer care
• Reputation and regulatory compliance

Banks and a few NBFCs with stock-backed lending counters seem to be reasonable players in Indian investors’ league.

Conclusion

Stock loan offers Indian investors an easy way out to access loans without relinquishing their stocks. We are referring to collaterizing your stocks where you remain the registered owner and still benefit from market appreciation and dividend distribution. Educate yourself about the nitty-gritty of this credit instrument, e.g., interest rate on loan against stock and standard terms, and puts the borrower at a lofty pedestal to make informed investment decisions.

For investors looking for timely liquidity at a lesser rate compared to the case of unsecured lending structures, a stock loan is a tactical vehicle. Its full potential can only be achieved by implementing prudent regard for risks, quality lenders, and repayment. Being part of a properly managed investment as well as liquidity strategy can add to your wealth creation and cash management in India’s growth economic cycle.

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