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Pros & Cons of Taking a Loan Against Shares

Published on May 2, 2022Updated on Nov 30, 2023

Pros & Cons of Taking a Loan Against Shares

Loans are a good way to finance wants and needs. Banks and Non-Bank Financial Company (NBFCs) now provide loans to assist to buy nearly anything, from electronic goods to a brand-new car. The loan application process is straightforward: You can apply, the lenders (banks) assess your creditworthiness, and if everything goes well, the funds will be deposited into your account shortly. This solution is perfect for individuals who need a certain sum for a one-time need. 

On the other hand, individuals (or business entities) may often need to borrow small amounts of money to manage short-term needs which can be easily repaid within a short time frame at periodic intervals of time. In such cases, it would be better to have a line of credit facility against which small amounts can be borrowed and repaid quickly. A loan against shares facility would be an excellent solution in such cases (providing that the individual owns listed shares). A loan against shares is now commonly issued as an overdraft with a credit limit set by the pledged securities. The borrower has the option of utilizing the entire sanctioned limit or a portion of it, depending on the funding needs. The borrowers can borrow and repay small amounts with this facility as many times as they like until the time comes for renewal. The interest is charged only to the utilized amount until it is repaid.

In order to meet urgent money requirements, it may not be a good option to sell securities and stocks as it can result in a potential loss that can be gained on long term shares. A loan against your stock is a great concept to borrow money at a lower cost (when compared to unsecured loans) without risking your assets. If you're thinking about applying for one, here are some pros and cons of a loan on shares to help you understand the benefits and drawbacks of a loan against shares. 

Pros of Loan Against Shares:

  1. Lower interest rates: Since a loan against shares is secured, the interest rates charged are much lower when compared to personal loans or other forms of unsecured loans. This is one of the main reasons why this facility is so popular. 
  2. There is no specified purpose: The loans that are made available to applicants can be used for any purpose. Lenders do not inquire about the loan's purpose for acceptance, just as they do with personal loans. This indicates you can use the money to buy a property, pay off a debt, or cover a medical emergency.
  3. No prepayment penalties: Most lenders who offer loan against shares have a one-year minimum term that can also be extended by paying a certain amount. The lenders do not charge the applicants on prepayment because the term is already short.

After looking at some advantages, let's dive in and evaluate some disadvantages. Below are some cons listed for taking loans against shares.

Cons of Loan Against Shares:

  1. Loan to Value (LTV): When the borrower asks for a loan against shares, the lender assesses the value of the shares the borrower has pledged and makes an offer. However, because lenders only offer upto 50%-85% of the value of the security depending on its nature, the amount sanctioned in the borrowers account may be less than the stock worth. The main reason for this is the volatility of the stock market, which makes financial assets such as shares a riskier asset when compared to traditional assets like immovable property.
  2. Companies on the list: Lenders often pay close attention to the company whose stocks are being pledged while examining the applicant's database. The loan application would be refused unless the company appears on the list of lenders. As a result, it is critical that the borrower reviews the list of companies before applying.
  3. Selling stocks: Once the loan gets granted, the borrower loses some control over equities. This means that if the borrower decides to sell the shares for a profit at a later date, the loan will prevent them from doing so. After the loan has been paid off, the borrower will have complete control over the stocks.

Unable to sell shares if they are trading at a higher price: If the stock market rises, the borrower will be unable to sell the shares since the bank has placed a lien on them. This implies that they can miss out on the chance to sell the stock at a greater price. In addition, if they are unable to repay the loan, the bank may be allowed to sell the shares, resulting in the loss of blue-chip stocks.

Considering the pros and cons, make a decision that suits you. SMFG India Credit offers eligible applicants a loan against securities like shares at attractive interest rates. Apply today to know more.

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*Terms and Conditions apply. Loans are disbursed at the discretion of SMFG India Credit.