Financial emergencies come unannounced. Such unexpected expenses can throw your financial situation out of gear, and you may look for ways to arrange funds quickly. While you can rely on an unsecured personal loan to come out of a financial emergency, you can also explore other cheaper, secured loan options; like a loan against fixed deposits, shares, life insurance policy and mutual funds.
Termed loan against securities, such loans are offered as overdraft facility after you pledge your securities as collaterals. They provide you with the twin benefit of availing funds through your assets while remaining invested in them.
So, how are loans against securities different from personal loans?
Personal loans are unsecured, meaning you don’t have to pledge any security against them. Unsecured borrowing, therefore, charges a higher rate of interest compared to secured borrowing. Additionally, you are required to pay interest only on the loan amount that you have used for a given period.
Now, let’s take a look at various aspects of loans against securities in detail, which might help you in deciding which option to go for when you have a requirement.
How loans against securities are offered
It must be noted here that there are only specified securities which can be pledged to secure a loan by the lender. Once a bank agrees to give you a loan against your pledged security, it will create a lien. The lien works as a security for the lenders in case the borrower defaults on the loan. Once the lien is applied on a loan, you cannot sell or cancel the pledged security.
Also, your loan amount would depend on the value of the security you will pledge as collateral. For the overdraft facility, the bank will open a current account to transfer the money. You can withdraw from this account whenever you need funds and repay the amount in the same account.
So, should you go for loan against securities?
A loan against security provides certain conveniences that you could consider. Based on the security you are pledging, you can fetch a high-value loan at a comparatively lower interest rate. This way, you don’t have to liquidate your asset; rather you remain invested and continue earning returns. The approval time for such loans are usually quick, and so, can come handy during an emergency. However, when you go for a loan by pledging your securities, it is important to understand the salient features of each type of security before making a decision. Below are some crucial pointers about each one of them.
Loan Against Shares: You can avail a loan against listed securities, and this includes stock exchange-traded securities such as government securities, corporate securities and debentures. There will be some amount of volatility attached to such types of loans as stock markets are volatile. So, if the value of shares you have pledged falls, the bank may ask you to pledge more shares as security or meet the value of the shares by paying money. Ideally, you should opt for this type of loan for a shorter duration to avoid volatility risks.
Loan Against Mutual Funds: In case you have invested in mutual funds, taking a loan against them comes as a convenient alternative. A loan against mutual fund works like an overdraft facility, and you are not required to either redeem your units or discontinue your Systematic Investment Plan (SIP) to borrow. Banks attach a lien to mutual funds when you borrow through this method, securing themselves the right to sell or hold the fund. You can bag a big-ticket loan and will be charged an interest rate of up to 11% on the loan repayment. Since the volatility factor is lower for most MFs in comparison to direct equity, this is a more viable option for short to medium-term needs.
Loan Against Fixed Deposits:Like other securities, loan against a fixed deposit is also hassle-free and convenient to obtain. The interest rate is dependent on the underlying FD rate, and is usually 1-2% above the interest rate you will get on your deposits. However, the interest is levied only on the amount used as loan and not the entire fixed deposit amount.
Loan Against Insurance: There are certain eligible insurance policies like ULIPs and endowment or life insurance policies which can help you get a loan by assigning them in the favour of the insurance company or the bank. However, you will be allowed a loan against your insurance policy only if premiums have been paid for 3 years before the loan application. Such a financing option might come to your rescue when you require a low-cost loan. However, it is very important to note that if the interest on the loan is more than the surrender value of the loan, you may no longer get the insurance cover from the assigned policy. (The author is CEO, Bankbazaar.com)