Equity markets are soaring to new highs as the coming of the new government at the centre has raised investor hopes of a slew of bold reforms and investment-friendly steps. Both benchmark indices, the BSE Sensex and NSE Nifty, are at an all-time high and most experts believe the recent rally is the beginning of a new bull-run on Dalal Street. But do you know this could also be one of the best times to monetize your shares without having to sell them?
If you’re a stock market investor and looking for borrowing loan, perhaps this is the best time to do it — through loan against shares (LAS), which is perhaps one of the ideal ways to get liquidity without liquidating them.
How LAS Works
A loan against shares falls under the category of loan against securities. There are various financial assets that can be used as loan against securities option. These are namely, equity Shares, mutual fund units, RBI bonds, life insurance policies, National Saving Certificate (NSC), Kisan Vikas Patra (KVP), among others.
The loan against equity shares is given by a bank/NBFC when you pledge your shares with it. The shares however must be in demat form. After fulfilling the eligibility criteria the bank gives you loan amount equivalent to 50% to 70% of the current market value of your shares. For instance, if you have stocks whose current market value is Rs 5 lakh, you are eligible to get a loan of Rs 2.5 lakh to 3.5 lakh.
Among the many advantages of loan against shares is that there are no EMI’s, you don’t have to look for a personal guarantor, no need to pay pre-payment charges and the interest is charged only on the loan amount you use. The tenure of the loan is usually 12 months and you don’t have to provide any additional security/collateral apart from the shares against which the loan is granted. However, there is a loan processing charge that could range from 0.25% upto 2% of the loan amount plus service tax. Many banks also give you the facility to trade/sell and swap your pledged securities. However, you can’t trade or sell shares more than the value of the pledged shares. You can also foreclose your loan anytime after paying the interest and the principal loan amount and the good this is that you don’t have to pay any foreclosure charges.
Are You Eligible
Apart from the usual KYC, banks/financial insitutions have laid down detailed eligibility criteria for loan against shares. One of them is that you must have a demat account for keeping shares. This demat account could be with any stock broker and need not necessarily be with the bank you’re planning to borrow from. Secondly, a borrower should have shares with the minimum market value of Rs 1 lakh. This means, if you have shares below Rs 1 lakh, you are not eligible to apply for the loan. Secondly, banks do not accept all stocks listed on the NSE or BSE. Instead, banks from time to time keep revising the list of specific stocks that can be pledged against the loan. Usually, these stocks are liquid and of reputed companies. Check with the bank you plan to pledge your shares to know the eligibility criteria.
When the bank approves the loan to you, it will open a current account for you where the loan amount is deposited. You will have to pay interest only on the amount you withdraw from this account and for the duration of time the money is utilised. The interest is usually calculated on a daily basis on the daily outstanding amount which needs to be repaid by you on a monthly basis.
Notwithstanding many advantages of loan against shares, there are a couple of downsides too. The most prominent is that you’ll have to maintain a minimum margin bracket that could range from 25% to 50% of the value of the approved shares. This means if the market value of your pledged shares falls below a stipulated margin threshold, your bank/lender will make a margin call to either provide more cash or pledge more shares to maintain the margin requirement. If you as a borrower are not able to pay up and maintain the minimum margin, your bank could recover the balance amount by selling your shares in the open market. Margin calls are usually triggered when there’s a slump in the market