A well-to-do software engineer, Neeraj Rastogi and his wife Sheetal were planning to renovate their home before the festive season. He got quotes from different contractors and arrived at an estimate of approximately Rs 4 lakh.
He did not have the cash at hand, but had funds from his mutual fund investments. However, these investments were for his retirement and his 5-year-old daughter’s higher education. The rest of his savings were in a contingency fund. This created a dilemma for Neeraj and Sheetal.
At the same time, they felt the renovation work was long overdue. The scribbles on the walls were an eyesore and the sofa was old and stained. With his daughter being older, he could safely repaint the walls and refurbish the sofa, as well have other remodelling work done.
But, to break his investments pained him, and though his investments were now worth Rs 8.5 lakh, he had an emotional value attached to them.
Neeraj was considering putting off the renovations until next year, when Sheetal showed him an advertisem*nt of ‘Loans against securities’ from a large private bank. The idea of a loan hadn’t occurred to him until now, simply because a large chunk of his salary already went towards his home loan and car loan instalments.
Several questions crossed his mind:
- Would he be able to bear the burden of an additional monthly instalment?
- Did securities mean specifically equity shares, or would it cover other mutual fund schemes as well?
- What if he wishes to foreclose the loan early?
Sheetal suggested that he meet the bank representative to get a clearer picture. The next day, Neeraj met the bank employee. What he learnt dissolved his misconceptions.
The loan against securities was not a conventional loan, where a monthly instalment needs to be paid; this type of loan worked very much like an overdraft facility. Neeraj was eligible for a credit of up to 80% of his pledged investments and needed to pay interest only on what he withdrew.
For example, if he was assigned a credit limit of Rs 5 lakh, but withdrew only Rs 2 lakh initially, he would be paying interest on Rs 2 lakh. Another benefit was zero prepayment charges.
Moreover, the securities he could pledge were not just equity shares, but equity, debt and hybrid mutual funds as well. Listed bonds, non-convertible debentures, fixed deposits and even insurance policies were also eligible.
This type of loan facility suited Neeraj best. His securities would remain untouched, while he availed of the credit as and when required. Though he pledged securities that would cover the Rs 4 lakh credit limit, he would not have to pay interest on the entire amount.
More importantly, in comparison to an unsecured loan, the interest was lower. If he had taken a personal loan or loan on his credit card, interest payments on the entire amount would have accrued from day one.
Like this, there were several other facts that he learnt about this unique type of loan facility. PersonalFN has highlighted 7 facts of loan against securities below:
- Rate of Interest – Lower than an unsecured personal loan
The rate of interest varies from bank to bank. From what’s provided on the banks’ websites, the rate of interest can vary from as low as 8.25% to as high as 12.50%. This depends on the creditworthiness of the investor, the type of securities pledged and other factors set by the bank. You can negotiate for the best rate.
- Loan up to 80% of the value of the securities pledged
This depends on the lender you are dealing with. For equity investments, such as shares and equity mutual funds, you can draw up to 50% of the value. Some banks may allow up to 60%. For debt mutual funds and other fixed income securities, you can avail of a credit of up to 80% or even 85% of the total Net Asset Value (NAV). In addition, if your bank is the depository participant (DP) for your Demat account, you may be eligible for a higher loan-to-value ratio.
- Loan provided only against the list of approved shares and mutual fund schemes
Certain shares, close-ended funds or schemes like Equity Linked Savings Schemes (ELSS), where the units are locked-in are not eligible. You will need to check with the bank for the list of eligible mutual funds or shares. Among the usual KYC and income proof documents, you need to submit a pledge form for the creation of a pledge. The shares or mutual fund units will be pledged to the lender.
- No EMI or Post-dated cheques required
The loan against securities operates similar to an overdraft or current account. Disbursem*nt will be by way of a credit limit set in your current account. Only here, the credit is secured by your investments, hence, you enjoy a lower interest rate. The interest is only chargeable on the debit balance for the period utilised. So, if you withdrew Rs 2 lakh and deposited the entire amount back in 20 days, you will be charged interest only for 20 days. This will certainly benefit those who need to make different sets of payments at irregular intervals. The default tenure for the credit facility is 12 months and you will need to pay a renewal charge or Annual Maintenance Charge at the end of each year.
- Portfolio is re-valued weekly
The credit limit set is reviewed weekly or even more frequently if you have pledged equity investments. Hence, if the credit taken exceeds the loan-to-value ratio set, either due to application of interest or revaluation of portfolio under pledge, you will need to lower it by depositing the required amount in your account. Failure to do so could attract a penal interest up to 18%-24% p.a. plus tax on the excess amount withdrawn. The penalty charge may vary upon bank.
- Nil prepayment charges
If you prepay the loan from your own sources, it will not attract any prepayment penalty. However, if this facility is taken over by another lender, a charge may apply.
- Fees and charges – Not limited to processing fees
There will be a processing fee set by the bank. The fees can range from as low as 0.15% to as much as 1%, subject to a minimum of Rs 1,000 or higher. Along with this, you need to bear the pledge and de-pledge fees. The renewal charge or AMC that is paid yearly differs from bank-to-bank and varies between 1,000 to Rs 10,000 depending on the amount of credit limit availed. As this facility operates similar to a current account, all charges related ATM facilities, cash deposits or withdrawals, NEFT or RTGS charges will apply.
Loans can certainly help in fulfilling your needs and make long overdue plans a reality. At the same time, excessive use of loans can lead one into a debt trap. This is an unpleasant situation no one wants to be in. Hence, ensure you have adequate finances and don’t take debt beyond what is required and manageable.
This is why, like Neeraj, begin to save regularly towards planned life goals. By setting S.M.A.R.T. goals, you feel motivated to achieve them. And this means, you might tend to think twice before withdrawing your investments.
Neeraj did not become financially savvy overnight. He spent some time every day to understand the nuances of personal finance and expand his knowledge. However, he had to scour through different sources to get correct and unbiased information.
Unlike Neeraj, you do not have to visit different sources to learn about planning your finances. All you need to do is sign up for PersonalFN's comprehensive A to Z e-course to become your own financial planner where you can manage your cash flows and plan for your financial goals.Along with this insightful video course material, you will also be eligible for more benefits.
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