Summary:
Loans against securities, also called portfolio-based lending or securities-based lending (SBL), refers to a type of loan where the borrower must pledge his/her investment securities to get the loan. This blog explains how borrowers can use their securities as collateral for loans.
Introduction to loans against securities
Loans against securities, also called portfolio-based lending or securities-based lending (SBL), refers to a type of loan where the borrower must pledge his/her investment securities to get the loan. These may include bonds, stocks, mutual funds and other types of financial assets. They are offered as collateral to get a loan from a lender or a financial institution. For individuals, these loans enable access to funds without having to sell the investments, which is an advantage in some situations. The following are some of the features and advantages of obtaining loans against securities:
- Collateral: Borrowers utilise their securities as collateral to get the loan. The liquidity and value of the securities directly determine the amount of loan a borrower can get.
- Liquidity: For investors, loans against securities are a handy way to access funds while still having ownership of their portfolios. This proves to be useful especially when there is a need for funds for expenses such as starting a business, buying a home or medical emergencies.
- Competitive interest rates: Loans obtained by using securities as collateral come with interest rates that are lower than unsecured personal loans or credit cards. This is because they are secured by the collateral.
- Quick access: The process of applying for and getting loans against securities is usually faster than regular loans because the lender is more concerned about the value of the collateral and not the credit history of the borrower.
- Flexible use: Borrowers have the liberty to use the money obtained from these types of loans for a number of purposes, including debt consolidation and investments, as well as for personal spending on things such as education expenses and home renovations.
- Tax efficiency: In some cases, loans obtained against securities come with tax advantages in comparison to selling the securities themselves. This is because selling the securities results in capital gains taxes. By borrowing against securities, individuals avoid having to realise those capital gains.
- Retained ownership: The borrower continues to have ownership of the investment portfolio and will continue to gain from any appreciation in the securities' value.
- Loan-to-value ratio (LTV): The maximum amount that can be received as a loan is determined by a percentage of the market value of the collateral. This is known as the loan-to-value ratio. The LTV ratio differs from lender to lender and may be affected by factors such as market conditions.
- Risks: Even though loans against securities have several benefits, they do come with their share of risks. For example, if the collateral's value falls significantly, the borrower may need to deposit more securities or repay the loan. This could result in the sale of the pledged securities.
How to get a loan against securities:
The process of borrowing money against securities depends on the lender and the securities that will be used as collateral. The following are some of the general steps that need to be followed for getting instant loans against securities:
Choose the right securities: Decide on the securities to be used as collateral. These could include bonds, stocks, mutual funds or other financial assets.
- Select a Lender: After conducting research, choose a credible lender that provides loans against securities. This can be a brokerage firm, a traditional bank, or a specialised lending company.
- Account and demat account: Make sure that you have a trading account with the lender, or a demat (dematerialised) account where the securities are held. Usually, lenders need you to hold an account with them or their affiliated brokerage.
- Assessment of loan eligibility: The lender assesses the value and liquidity of the securities that are being offered as collateral. The amount of loan that can be received depends on the value of the securities.
- Completion of application: After discussing and agreeing on the terms and conditions, the loan application is handed over by the lender. The applicant needs to provide the necessary details to receive approval for the loan.
- Pledge of securities: The borrower has to sign a pledge agreement or a power of attorney in favor of the lender to be able to authorise the use of the securities as collateral.
- Evaluation and disbursement: The lender evaluates the value of the securities and offers a loan, the amount of which is based on a certain percentage of that market value. Once the approval is received, the money is disbursed to the bank account.
- Repayment: The borrower has to make regular repayments based on the agreed-upon terms, failing which the lender has the right to liquidate the securities to recover their money.
- Monitoring of the securities: Investors need to track the performance of the securities because their value will affect the loan-to-value ratio. If the value falls significantly, it may be needed to provide more collateral or pay down the loan.
Summing up
It's imperative for borrowers to understand the risks associated with using securities as collateral for loans. If the securities' value falls significantly, more securities may need to be deposited or the loan may need to be repaid to keep the lender from selling the collateral. A thorough understanding of the terms and conditions of the agreement is a must. The terms and interest rates may vary, because of which it is important to assess the options and choose the option that works best. Help from professionals who have adequate experience can make it easier to get instant loans against securities.