Loan-against-securities a good bet for short term goals

Securities pledged are considered as collateral against the amount withdrawn while a pre-sanctioned amount is available up to which the borrower could withdraw. This is nothing new but the current offering has become seamless due M to the adoption of digital transactions

The very idea of financial planning is to achieve various desired goals at the required times. As we say plan turns static, but life is very dynamic, how much we add to the variables to our plan. We do build emergency funds to counter many shocks but then life comes up with newer surprises each time, not all times unpleasant though. How to address these short-term, at times, unplanned needs without hurting much of the long-term investments?

We build portfolios of various investments keeping in mind the different goals or needs in mind. We could use them to liquidate to address these at an appropriate time but there could be a shortfall in the need either due to last-minute change of plans or under-budgeted at the first place and even overshot the initial plan. In those cases, we could use leverage ie, loan to cover the deficit but not all times is it quick or practical.

This is when one could resort to loan against securities. A security is nothing but any financial instrument or a certificate that has a monetary value and could be traded. They’re broadly classified into equities (stocks etc) and debt (bonds, debentures, etc). Of course, other instruments like life insurance policies, mutual fund (MF) units, gold bonds, National Savings Certificate (NSC) and other sovereign bonds are also considered as securities.

So, when investing in these, some of them could be highly liquid i.e., could be traded or sold immediately like those of equities and mf, but by selling the investor tend to liquidate them out permanently for a very temporary cause. Also, the market volatility could impact the value of these instruments at the time of sale while also add tax liability over the sale proceeds and exit costs/ loads if any applicable. Instead, the investor could pledge these securities and generate cash on an immediate basis to address his current need.

The Loan-Against-Securities aka LAS is providing fi nancial assistance up to a defined limit over the securities pledged at a consideration ie, interest. Usually, an overdraft account is opened against the borrower with a limit equal to the predetermined percent of the pledged securities. Interest is charged on the withdrawn amount during the period. As the securities are pledged, the borrower loses the right of ownership till they clear the loan or to the extent of overdraft facility utilised.

In simple understanding, the securities pledged are considered as collateral against the amount withdrawn while a pre-sanctioned amount is available up to which the borrower could withdraw. This is nothing novel or new but the current offering has become seamless due to the adoption of digital transactions. The entire process could be validated and executed online especially if the securities are in demat form with an instant disbursal option. Many of the popular funds are accepted or pre-approved in the lender’s list making it convenient for the borrowers.

The LAS thus not only provides the instant liquidity needed to tide over the short-term requirement but also eliminates the unnecessary costs of taxation, exit loads, loss of indexation benefits (in case of debt/hybrid funds), etc. Also, the borrower doesn’t lose the complete ownership but could be released by clearing the outstanding amount. Moreover, the interest rates are attractive and relatively lower than those of the credit card or personal loans which are economical also. At times, the market returns are way higher than the interest rate charged thus making this option a very viable one.

While it seems all rosy, an individual must examine the terms and conditions carefully, understand the potential implications, risk factors and the interest rate offered. Though, the lender reserves a percentage of the securities to offset market volatility, it’s not ideal to pledge the entire portfolio for a short-term requirement. The attractiveness of this option loses as the tenure of the loan period increases.

(The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])