Loan against shares: Why you should avoid them?

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Loan against shares: Why you should avoid them?
Though loan against shares held in dematerialized form helps to tide over short and medium term financial crunch, the same should be avoided as far as possible. As such a loan is provided by banks with several conditions and limitations. Below are stated some such constraints in respect of loan against shares.

1. Loan against shares is offered only in respect of some scrips that are top-rated i.e. banks disburse loan against company scrips that hold a 'AAA' rating. Illiquid scrips and other scrips which are not traded cannot be pledged with banks for securing loan.

2. Banks do not provide loan against a single share and instead offers only against multiple scrips as the same serves as a hedge for the bank in case price of a particular scrip falls sharply.

3. Loan against shares is granted by the bank by marking a lien on the shares i.e. banks have the right to realize the proceeds of the sale of the pledged shares in the event of non-repayment of the loan amount by the borrower.

4. Loan to value amount is generally not more than 50% i.e. in case you need a loan amount of Rs. 5 lakhs you need to possess a stock portfolio of over Rs. 10 lakhs for pledging with the bank.

5. As prices of shares are subjected to high volatility, banks prefer to offer other loans that are backed by a collateral which usually rises in value, for instance: loan against property.

6. Loan against securities attracts a higher rate of interest in comparison to other loans such as property loan which is generally cheaper by 100 basis points. Contrarily, loan against shares is cheaper in comparison to personal loans

7. Banks insist borrowers of loan against shares to provide an undertaking stating that the disbursed loan amount shall not be used for speculative activities.

Other points to know about loan against shares

Borrower of loan against shares will continue to earn dividend income even when the shares are pledged with the bank. The lien on the pledged shares will be lifted once loan repayment is done.

Banks acting as depository participant can also pre-sanctioned loans against shares held in dematerialized form.

Such loans involve huge margins as the value of the underlying pledged security is highly volatile.

Story first published: Monday, January 6, 2014, 12:57 [IST]
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