Need money? Why pledging demat account shares for a loan is better than selling them

Need cash urgently for a short tenure? Your shares can come to your rescue without the need to sell them. We are talking about taking a loan against the security of your shares. In this article, we will understand why taking a loan against shares is better than selling them.

What is a loan against shares?

A loan against shares (LAS) is one where you offer your shares as collateral/security to the financial organisation giving the loan. Most financial organisations provide an overdraft facility against the security of loans. You can use the money as and when required up to the approved limit. The interest is charged only on the amount utilised and for the number of days utilised.

You can repay the loan amount as per your convenience without any penalties. Usually, the loan tenure is one year. It can be renewed by paying the required fee.

Pledging of shares

You will have to pledge your shares to avail a loan against them. The bank will mark a lien on them. As a result, you will not be able to sell those shares till you repay the loan and the bank removes the lien. You can choose which shares you want to offer as security for the loan. However, an important point to note is that banks offer loans against shares of companies that are big in size and have good liquidity.

The loan is offered up to a specified value of the shares, known as loan to value (LTV). For example, in the case of shares, the bank may offer a loan with an LTV of 50%. In this case, for shares with a value of Rs. 100, you will get a loan of Rs. 50. The bank keeps a margin of safety as share prices are volatile and subject to falls.

When should you go for a loan against shares?

If your loan requirement is for a shorter tenure ranging from a few months to a year, consider a loan against shares rather than selling. Also, if you want to hold on to the shares for the long term and believe they have the potential to create wealth for you, consider taking a loan rather than selling them.

All good companies go through a difficult face from time to time before bouncing back. It may happen that the shares of companies that you are holding are going through a correction. They may have the potential to do well in future. If you sell them at this juncture, you will not get the best value from them. Hence, at such times it will make sense to hold the shares and take a loan against them rather than selling them.

Currently, the overall market is at or near all-time highs. As the Indian economy continues to do well, the bull run may continue. Along with the overall market, the share of companies that you are holding may also be doing well. Hence, selling them at this stage may not be a good idea, as you will have to forego future gains. Therefore, in such a scenario, consider taking a loan against the shares instead of selling them.

If you sell the shares, there will be capital gain implications. Depending on the holding period, the capital gain will be categorised as short-term or long-term capital gain and taxed accordingly.

Benefits of a loan against shares

Some of the benefits of a loan against shares include the following.

Continued ownership of shares: When you take a loan against shares by pledging them, you continue to own them. You will benefit from the upside in the share prices.

Benefit of corporate actions: Even after taking a loan against shares, as you continue to own them, you will benefit from the corporate actions declared by the company. For example, you will get the dividends, bonus shares, stock splits, etc., announced by the company.

Lower interest rate: The loan against shares is a secured loan. Hence, banks usually offer it at an interest rate lower than an unsecured loan like a personal loan.

Faster approval: As the loan against shares is a secured loan, the probability of it getting approved is faster than unsecured loans. If you can create the pledge on shares and complete the documentation quickly, the bank can approve the loan within a day or so.

Flexibility: As the loan against shares is offered as an overdraft, it provides flexibility compared to fixed EMI-based loans. You can use the money as and when you want and repay it whenever you have the required funds. The interest is charged for the amount used and for the number of days used.

Points to take note of

When you take a loan against shares, you need to consider the fact that you will get a loan only up to a certain value of shares (LTV) and not the entire value. If the value of shares falls below a certain level, it will result in a margin call. You will have to give more shares as collateral for the same loan. If you don’t provide the required shares or prepay part/entire loan amount, the bank can sell the shares to recover the loan money. In that case, you will lose ownership of your shares.

How to take a loan against shares?

Not all banks/NBFCs provide a loan against shares. The product features include the minimum and maximum loan amount, borrower’s age, interest rate, loan to value, processing fee, renewal fee, etc.

1. Check the product features and accordingly shortlist the bank/NBFC.
2. Complete the pledging of the shares based on the company whose shares you want to pledge and the number of shares you want to pledge.
3. Complete the documentation process.
4. The bank/NBFC will approve the overdraft limit, and you can start using it.

Loan against shares provides you the flexibility to use the overdraft amount as per need. You continue to own the shares and enjoy all its benefits like the price increase, dividends, etc. Hence, for short-term financial requirements, if you have to choose between taking a loan or selling shares, consider taking a loan. Apart from shares, a loan against security can also be availed against mutual fund units, Government securities, corporate bonds, insurance policies, etc.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.