Borrowing against shares isn’t a good idea

Have a big ticket expense coming up? With the equity market zooming to all-time highs, you may be tempted to borrow against shares and other eligible securities that you hold. But think before you plunge.

We give you four reasons why you should exercise prudence while borrowing against your equity investments.

First, the amount you get as loan against equity shares is never certain. It depends on the shares you wish to pledge and your credit history. Even then, most banks may lend only up to 50 per cent of the current value of your equity shares. You cannot rest after you get the loan either.

If the stock prices fall sharply after your loan has been sanctioned, you may have to tender additional shares or make additional cash payment to maintain the margin. This means that you will need adequate cash flows to meet margin requirements, should the equity market remain volatile. In case you are unable to pay the additional margin or fail to pledge additional shares, the bank will charge you additional interest on the overdrawn amount. However, should stock prices rise during the term of the loan, the loan value will also increase proportionately.

Second, the borrowing rate is also high, considering the risky and volatile nature of the underlying shares. For instance, State Bank of India charges almost 16.5 per cent interest on loans against equity shares. In addition to this, you may have to incur additional charges, such as processing fees and service tax.

The interest is calculated on the amount you withdraw from the loan account. But if you fail to pay the interest on time or if your borrowing exceeds the loan limit, you will have to pay additional penal interest.

For instance, Axis Bank charges penal interest of almost 24 per cent per annum.

Likewise, ICICI Bank charges 6 per cent over base interest on overdrawn amounts.

Third, most banks lend only against a limited, pre-determined set of stocks. As such, all the equity shares that you hold may not qualify for the loan. The list is usually restricted to high quality, liquid stocks that the bank can easily sell in case you fail to repay your loan amount. If you hold lesser known small-cap stocks with poor liquidity, you may not be able to borrow against them. For instance, HDFC Bank’s approved lending list has barely 383 stocks out of the BSE’s listed universe of over 5,000 stocks. Likewise, ICICI Bank’s lending universe is limited to just 690 stocks.

Fourth, the loan is largely meant to help meet your short-term financial needs. The loan account is valid only for one year. If you wish to extend the loan beyond a year, you will have to renew it at an additional cost. The additional charges for renewing your loan vary from one bank to another. For instance, ICICI Bank charges ₹2,500 plus service tax for annual loan renewal.

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