Pledging investments for Loans: How to choose the right loan?
Historically, people have been pledging their assets as collateral with lenders to get cash/liquidity for funding their personal/business or other expenses. Since Real estate and Gold were among the most widely owned assets, their use as a security for availing loans was popular.
As the economy evolved, numerous investment opportunities emerged. Retail investors now have investments in various asset classes such as Mutual Funds, Shares, Insurance, Gold, Property, Fixed Deposits, Bonds, PPF, and others.
In this article, we will understand how pledging works with each of these asset classes and the benefits & limitations associated with it.
Pledging Mutual Funds Units
You can secure a loan using your mutual fund units as collateral, where the lender offers between 45% to 80% of the pledged mutual funds' value (referred to as Loan to Value - LTV). The loan amount depends on the type of mutual funds pledged—debt mutual funds typically allow for an LTV of approximately 80%, while equity mutual funds range from 45% to 50% LTV.
This secured loan option generally incurs lower interest rates compared to unsecured alternatives such as personal loans. The approved mutual funds can differ among lenders. Typically, close-ended mutual funds or units under a lock-in period are not eligible for lending.
Usually offered as an overdraft facility with a one-year tenure, renewable thereafter, this loan option serves well for short-term financial needs or managing cash flow. It allows access to funds without selling your investments. While retaining ownership of the mutual funds, you still benefit from returns, dividends, etc. The only restriction is that you cannot sell the mutual funds unless you de-pledge them.
To know more about loan against mutual funds
Pledging of Shares
Similar to pledging mutual funds, you can pledge shares as collateral to obtain a loan. The lender typically extends a loan amounting to 50% of the shares' value that you pledge.
This type of secured loan generally carries lower interest rates compared to unsecured loans. Lenders usually offer this facility against a selected list of shares, determined by their criteria. The approved list of shares and the Loan-to-Value (LTV) ratio can vary between lenders. For instance, lender A might provide a 45% LTV for shares of a particular company, whereas lender B might offer only 35% for the same company's shares.
A loan backed by shares proves beneficial for short-term financial needs or effective cash flow management. It allows you to access funds without liquidating your investments. The shares' ownership remains with you, ensuring that you continue to receive all associated corporate benefits such as returns, dividends, stock splits, and more.
To know more about Loan Against Shares
Insurance as collateral
Securing loans by pledging insurance policies has been less popular. The eligibility for securing the loan is dependent on the surrender value of the policy. The surrender value of a policy is the amount received at the time of early policy exit. A loan amount of up to 90% of the surrender value may be availed, varying across different lenders. An interest rate of 10-15% is charged. Repayment options and loan tenure differ among lenders.
All policies do not qualify for a loan against insurance. Generally, policies with substantial cash or investment value can be pledged to avail of a loan. Policies like term insurance which don’t accumulate cash value, are not eligible.
The lending procedure requires collaboration between the insurer and lender, adding complexity compared to dealing with other assets. If the loan isn't repaid, the policy may face termination. The lender will recover the outstanding sum from the insurance policy's surrender value, leading to policy termination. When assigning insurance policies as collateral, it's crucial to understand the terms, risks, and consequences before opting for this path.
Gold loan
Gold's historical significance as a trade currency has established its widespread acceptance as collateral. Loans can be secured against pledged gold at values ranging from 75% to 90% of its worth. To access pledge gold for loans, individuals must either visit a lender's branch or get in touch with a relationship manager. Interest rates typically span between 9% and above 20%, which may depend on repayment frequency, gold valuation, and prevailing market prices.
Pledging gold jewellery ranging from 18 to 22 karats and bank-minted coins (limited to 50 grams per client) qualifies for loan collateralization. Loan terms, gold valuation methods, and interest rates tend to differ across various lending institutions. In the case of higher-value loans, lenders might request income tax return (ITR) documents. It's important to note that the valuation of pledged jewellery doesn't take into account the worth of precious stones incorporated within it.
Loan Against Property
Real Estate stands as a recognized asset often pledged to secure larger loans. Lenders extend loans based on the property's worth, influenced by factors such as location and market conditions. Competitive interest rates make property loans appealing for substantial financial requirements. Yet, leveraging property involves intricate legal and administrative procedures, including property valuation and documentation. Release of the hypothecated property after loan repayment presents its unique set of challenges.
Fixed Deposits Overdraft facility
Fixed deposits, commonly referred to as FDs, serve as assets eligible to be pledged as loan collateral. Termed FDOD, lenders extend loans based on FD valuation, often up to 90% of the FD's total value. Interest rates for loans backed by FDs tend to be lower compared to unsecured loans, typically ranging from 0.5% to 2% higher than the interest annually accrued from the FD. Pledging FDs for loans involves a simple process, offering a convenient solution for individuals seeking immediate funds while preserving their FD investments.
Pledging of Bonds
You have the option to pledge government or corporate bonds for loans by using them as collateral. Lenders might extend loans, up to 95% of the bond's worth, depending on the bond type. The interest rates for these loans vary among lenders. Government bonds carry less risk compared to corporate bonds, resulting in secured loans backed by government bonds potentially offering a higher loan-to-value ratio (LTV) and lower interest rates. This process may also involve temporarily transferring ownership of the bonds to the lender for the loan's duration.
PPF as collateral
PPF accounts, a means of long-term savings, can serve as collateral for loans under some circumstances. The loan amount is typically a portion of the PPF account's total balance, and the interest rate for PPF loans tends to be comparatively low. Opting to pledge a PPF account becomes a viable choice during urgent fund requirements as withdrawing from the PPF isn't feasible due to its long-term nature.
The table below presents an overview of all the loan types mentioned above
| Instrument | LTV ( Loan to Value) | Interest Rate (p.a.) | Ticket Size (in Rs.) | Tenure | Processing Time | Income Proof |
|---|---|---|---|---|---|---|
| Equity Mutual Funds | 45% - 50% | 8.5 - 20% | 10,000 - 5 crore | 1 year & renewable thereafter | Digital: 15 minutes Physical: few days |
Not required |
| Debt Mutual Funds | 80% - 90% | 8.5 - 20% | 10,000 - 5 crore | 1 year & renewable thereafter | Digital: 15 minutes Physical: Few Days |
Not required |
| Shares | 30% - 50% | 8.5 - 20% | 10,000 - 5 crore | 1 year & renewable thereafter | Digital: Same day Physical: Few Days |
Not required |
| Insurance | Upto 90% of surrender value | 10 - 15% | 10,000 - 25 crore | Upto 8 years | Few Days | Not required |
| Gold | 75% - 90% | 9 - 20% | 1,000 - 50 lakhs | Upto 4 years | Same Day | Not required |
| Real Estate | 40% - 75% | 8.5 - 18% | 2 lakh to 25 crore | Upto 20 years | Few Days | ITR/Salary Slip required |
| Fixed Deposits | 80% - 95% | FD Interest + (0.5% -2%) | as per FD amount | Upto FD maturity | Digital: 15 minutes Physical: Same Day |
Not required |
| Bonds | Upto 95% | 9 - 20% | 15,000 - 5 crores | 3 years | Few Days | Not required |
| PPF | Upto 25% | PPF Interest rate +1% | Maximum of 25% of the balance at the end of the second financial preceding the year in which the loan is applied | Upto 3 years | Few Days | Not required |
Disclaimer: This data is prepared based on available information on the web and may differ from lender to lender.
Conclusion:
Pledging investments is an efficient approach to use the worth of your assets without losing ownership. Whether they include Mutual Funds, Shares, Gold, Real Estate, Fixed Deposits, Bonds, or even insurance policies and PPF, every asset category possesses its distinctive capability to generate immediate funds during critical times. Yet, prior to selecting the option to pledge assets, understanding the conditions, terms, interest rates, and potential risks associated with each asset type is important. Equipped with this understanding, you can confidently embrace the concept of pledging assets as collateral for loans, unlocking an effective strategy to maximize returns from your investments.
Disclaimer: This article is prepared based on available information on the web and may differ from lender to lender.
