Life is full of emergencies. Your spouse is unwell and has to be hospitalized. This is an emergency which requires money. Your son is studying to be a doctor and the medical fees are in lakhs of rupees. You have to pay his college fees soon and this is an emergency. Most emergencies cost money. So what do you do in an emergency? Do you avail an emergency loan such as a personal loan, which charges you a high rate of interest? Should you avail a loan against your shares?
Are you an investor in shares? You can pledge these shares with a bank and avail a loan against these shares. Banks have a list of pre-approved (eligible) shares, against which they are willing to offer you a loan. Your shares are the collateral (security) for the loan. If you want to avail a loan against shares, banks take a lien against your shares.
Banks have a right to sell your shares and recover their dues (lien), if you default on your loan. Banks open a current account in your name, with an overdraft facility. You can borrow up to a set limit, based on the collateral (shares) you pledge. You can withdraw money from this current account if you have a need. You then repay the amount you have borrowed, by depositing money in the current account. You are charged an interest on loan against shares, which is lower than interest on a credit card or a personal loan.
Banks do not lend more than 50% of the value of your shares, which you have pledged to avail the loan. If you want to avail a loan of INR 5 Lakhs, you will have to pledge shares worth INR 10 Lakhs. There is also a chance that a bank might sanction your loan, which is lesser than 50% of the value of your shares.
Banks have a list of pre-approved shares against which they sanction your loan. The shares you pledge need to be in that list. If the shares you pledge are not in the pre approved (eligibility) list, then banks will not sanction a loan against these shares.
You delay the repayment of your loan. You have to pay a high penalty. Banks would charge you an interest as high as 20% to 24% a year, if you delay the repayment of your loan. You also have loan processing fees (non refundable fee charged to process your loan), which could be quite high.
A stock market crash can be real bad news for you, as the value of the shares you have pledged decreases. You are eligible for a particular loan amount. The stock market has crashed and the outstanding loan amount (amount which you have to repay), is now higher than your eligible loan amount. This is simple….If the stock market crashes, it is highly likely that the value of the shares you have pledged decreases. You (borrower), then need to settle the difference. Let us understand this with an example… You have pledged INR 10 Lakhs worth of shares to avail a loan of INR 5 Lakhs (50% of the value of your shares). After the stock market crash, the value of your shares is INR 8 lakhs. You are now eligible for a loan of only INR 4 lakhs. You have to pledge shares worth INR 1 lakh, to make up for the shortfall.
Banks lend only against multiple shares
If you want to avail a loan against shares, you would have to pledge shares of different Companies. This gives banks the diversification benefit. If you pledge shares of only 2 or 3 Companies, there is a high risk on your loan for the bank. If these Companies do not perform and their share prices crash, the bank would suffer.
You need to note these points before you avail a loan against shares.
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