7 things to keep in mind when borrowing against stocks or mutual funds

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Borrowing against equity holdings such as stocks or mutual fund shares is not very common. However, it is one of the most convenient and quickest ways to arrange funds, that too, at a lower interest rate. Investors who are exposed to equity-based instruments may consider loans on these stocks and mutual funds to meet their financial needs. This may be a better option than redeeming your mutual fund units or selling some or all of your shares. A title loan allows you to keep your investments intact while financing your emergencies.

Here are some crucial points you need to remember when getting loans on your mutual fund units and shares.

1) Demat funds with update KYC: You must ensure that all assets you intend to pledge are in demat format and that all KYC related details and documents whether you are an Indian resident or a non-Indian resident are updated with your broker and your bank.

2) Entries must be approved: Only shares of listed companies are generally eligible for a loan. They should not be banned or delisted entities. The same is true for mutual fund shares. They must not be in a separate scheme by the fund house due to defaults. Additionally, the lenders themselves have a list of companies and funds approved by their boards. If your assets do not fall into these two categories, they may not be accepted as collateral.

3) Loans against securities have a margin: The amount of the loan is generally between 50% and 80% of the value of the assets you put up as collateral. This varies from lender to lender. However, the minimum loan available through this route is Rs 50,000 to a maximum of Rs 20 lakh.

4) You have to pay interest: The loan availed on participations and shares of mutual funds bears interest. As a general rule, compared to the personal loan, the interest on securities loans is much lower. Depending on the banks, interest of around 7 to 15% per year may be charged to you. However, the advantage is that the stock loan is available as an overdraft loan and you are only required to pay interest on the amount used. For example, say you are offered a loan of Rs 5 lakh as overdraft on your account. If you draw Rs 2 lakh and deposit the same amount in your account in one month, you are only liable to pay interest for one month on Rs 2 lakh. In short, you have to pay interest only on the amount of funds you use instead of the sanctioned amount.

5) Total or partial pledge: You can partially or totally pledge your securities, depending on the amount required. If the amount is low, you can pledge some of your assets. It is prudent to have a rough calculation when deciding how much collateral you would need to pledge to meet your needs. After logging into online banking, you can pledge your assets to equities depositories such as NSDL and CDSL online by confirming the OTP.

6) You cannot sell or exchange your pledged securities: As soon as you benefit from the securities loan, your pledged shares or mutual fund units are subject to a lien. This basically means that you cannot accept any trade or sales calls until you have repaid the amount to the lender.

7) Lenders can liquidate your pledged securities if you default: If you are unable to repay the loan amount with interest during the term of the loan, the lenders have the right to liquidate your assets and recover the amount.

Stocks and mutual funds are your assets. Hence, you can take a loan against them, and that too at a much lower rate compared to an unsecured loan. The lender, however, will check your credit score and eligibility and assess the value of your units before sanctioning a loan. Also, before taking out a loan against stocks and mutual funds, assess your needs and repayment capacity. The cost of defaulting on a loan against securities can be more than just an impact on credit rating. Remember that if you default, you will lose the investment. So be careful when deciding to take out a loan and repay it on time so you don’t lose your investments or hurt your credit score.

(Disclaimer: The opinions expressed in this column are those of the author. The facts and opinions expressed here do not reflect the views of www.timesnownews.com.)

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