Loan Against Shares: Meaning, Working and Eligibility

Loan against shares

A loan against shares, or LAS, is a credit facility through which you can use your equity or mutual fund holdings as collateral to get a loan or borrow money, without selling the shares or the units. 

This allows you to benefit from the share price increase, while you pay interest only on the borrowed amount. However, if share prices fall, the lender may ask you for additional collateral or cash deposits.

A known example is Elon Musk, who has used loans using his share holdings in Tesla and SpaceX to raise funds for business and personal use. 

This approach allows you to access your own capital without having to pay capital gains tax that would arise from selling the stock. 

How Loan Against Shares Works

A loan against shares follows a structured process where your investments act as collateral. You receive access to funds while continuing to own your pledged shares, subject to the lender’s terms.

• Pledge your shares: You pledge eligible shares or mutual funds in your Demat account as collateral. The investments remain in your name and are not sold.
• Loan amount is approved: The lender assesses your portfolio’s stock market value and sanctions a loan based on the permitted loan-to-value, or LTV, ratio for eligible securities.
• Withdraw funds when needed: The loan is usually offered as an overdraft facility. You can withdraw money as required and pay interest only on the amount used.
• Repay and release the pledge: You repay the borrowed amount and applicable interest according to the loan terms. Once fully repaid, the lender removes the pledge from your shares.

Eligibility & Requirements

Here are the eligibility criteria and requirements to get loans against shares:

Eligibility and requirements	Details
Eligible Applicant	Indian resident individuals, including salaried and self-employed applicants, can apply subject to the lender’s credit assessment.
Approved Securities	You must own eligible listed shares, mutual funds, bonds, or other securities accepted by the lender. The securities must be present in a Demat account.
KYC Documents	You will need a valid identity and address proof with a PAN, Aadhaar, and recent photographs to complete the application process.
Demat & Bank Account	You must have an active Demat account to use your assets and a bank account to get the loan amounts, and also for repayment purposes.
Loan-to-Value (LTV)	For listed shares, banks can lend up to 60% of the market value. Equity mutual funds, ETFs, REITs, and InvITs have a 75% cap, while highly rated listed debt securities can go up to 85%.
Repayment Capacity	Lenders may assess your repayment ability and credit profile before approving the loan, even if the shares provide adequate collateral.

Benefits of Loan Against Shares

Here are some of the key benefits of choosing this financing option:

• You still own your investments:

You can get the loan money and still get to keep your shares. This means you will still get the dividends and bonuses from your shares, and the price of your shares might go up over time.

• It does not cost much to borrow:

Since you are using your shares as security for the loan, the interest rate is usually lower than it would be for a regular loan. This makes it cheaper for you to borrow money.

• You can get money when you need it:

A lot of lenders let you take the loan as an overdraft. This means you can take out money only when you need it. You only have to pay interest on the money you are actually using. 

Risks & Limitations

When you get a loan against shares, there are some things about it, but there are also some risks. You should know about these risks so you can make decisions when you borrow money.

• Market price fluctuations: 

If the price of the shares you put up as security goes down a lot, the bank might ask you to give them security or pay back some of the loan against shares.

• Possibility of losing shares: 

If you do not pay back the loan against shares or do what the bank wants, they might sell the shares you put up as security to get their money back.

• Borrowing Limit Applies: 

The amount of money you can borrow against shares depends on how much the shares are worth and what the bank says you can borrow, which might not be enough if you need a lot of money from the loan, against shares.

Loan Against Shares vs Personal Loan

Now, let us see how loans against shares differ from personal loans!

The following table discusses the key difference:

Basis	Loan Against Shares	Personal Loan
Collateral	Shares or other eligible securities are pledged.	No collateral is required.
Interest Rate	Interest rates are lower compared to personal loans.	Interest rates are generally higher.
Loan Approval	Approval depends on pledged securities and eligibility.	Approval depends mainly on income and credit score.
Ownership of Investments	You continue to own the pledged shares.	No investments are involved.
Loan Amount	Amount depends on the portfolio value and LTV.	Amount depends on income and repayment capacity.
Repayment	Many lenders offer flexible overdraft-based repayment.	Fixed EMIs are paid throughout the tenure.
Risk	Falling share prices may call for additional collateral requirements.	No market-related collateral risk exists.

Real-Life Example

Let us discuss Elon Musk’s example here in detail!

Since a lot of Musk’s wealth depends on his Tesla shares, he uses those shares to get funds.

In the year 2022, when Musk was raising capital to buy Twitter, now called X, for USD 44 billion, he got a USD 12.5 billion loan using his Tesla shares as collateral.

Later, he reduced the loan to USD 6.25 billion by bringing more investors, and eventually got rid of it by using more equity financing.

This example shows how a loan against shares can give you funding without having to sell your investments. It also shows why it is crucial to understand the risks of the market before borrowing against your stocks.

Smart Usage Strategy

Following a plan when you borrow money helps to reduce problems and makes sure your investments keep helping you achieve your long-term money goals:

• Borrow only what you need:

Use the loan amount when you need money, and do not borrow the maximum amount you can get, so you have some extra money just in case.

• Monitor your portfolio regularly:

Keep an eye on the investments you have used for the loan, especially when the market is not doing well, so you can act fast if the lender needs something.

• Repay the loan on time:

Pay the interest and the money you owe on time so you do not have to pay fees. This way, you can keep your investments safe without the lender selling the investments you used for the loan.

Common Mistakes Investors Make

Taking a loan against shares can be a practical financing option. However, poor borrowing decisions may increase your financial risk. 

Therefore, you must avoid the following mistakes to manage the loan effectively:

• Borrowing more than necessary: Taking a bigger loan than you require, it can increase the interest costs. This also leaves you with room to handle unexpected market changes.
• Ignoring market movements: Not keeping an eye on the value of your pledged shares can lead to margin calls. You may also get requests for collateral when the market is going down.
• Missing repayment deadlines: Delaying interest or loan payments can result in penalties. It may also give the lender the right to sell your pledged securities.

Final Thoughts

A loan against shares is a way to get finances without selling your investments. This lets you benefit from your portfolio and make it useful for short-term needs.

However, before you apply for it, you should compare lenders, understand the LTV limits, and understand your repayment capability. You must borrow responsibly and monitor your pledged investments regularly to make it useful.

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