However, there may be situations in which it is more appropriate to liquidate these assets than to take out a loan against them or obtain another loan for them. Read on for more information.
Liabilities by way of pledge of assets
Loans backed by securities are generally offered in the form of overdrafts. This means that the amount of the loan is approved by the bank and that you can use this amount in its entirety or in one or more instalments. Many banks offer online securities-backed lending.
As a rule, you must give the bank a guarantee in order to be able to use the loan. You may also need a demonstration account at the bank to obtain loans in the form of shares, National Savings Certificates (NSC) and Kisan Vikas Patra (KVP).
Interest is generally calculated on the amount of the loan outstanding at the end of each month. The amount of the loan and the interest rate may vary depending on the profile of the person, the type of collateral and the duration of the property. Because you give the bank a guarantee, the bank is prepared to give you a loan, even if you do not have a good credit rating. However, if you have too many defaults or arrears on other loans, the lender may charge a much higher interest rate on the loan and give you a much smaller loan compared to the value of the assets or the collateral or both, says Adhil Shetty, CEO and co-founder of BankBazaar.com, an online marketplace for financial instruments.
They are generally cheaper than personal loans. For example, the interest rate on loans to private individuals can range from 12 to 24 per cent a year or more, but currently securities lending is available in a range of 9.25 to 12 per cent a year. In addition, a loan with real estate as security is granted at a relatively low interest rate – less than 9% per annum (see graph).
However, other costs should also be taken into account. For example, HDFC Bank Ltd. calculates a fixed processing fee at ₹1.499 when you apply online for a loan backed by investment funds or bonds. In the case of an offline process, 1% of the allowed amount or ₹3 500, whichever is greater, will be charged. In addition, the Bank also charges an annual service fee of up to 0.50% of the approved credit limit, with a minimum of ₹1,000 and a maximum of ₹5,000. In addition, there are costs such as stamp duty, legal taxes, advances, etc.
Security loans usually have a term of one year and if you want to extend the loan, you may have to pay a renewal fee. For example ICICI Bank Ltd. charges a renewal fee to ₹2 500 per year at the end of each year. These fees do not include the Goods and Services Tax (GST).
What were you supposed to do?
Ideally, you should have an emergency fund, but if you are in a situation where you need money, you should first consider your options. Compare the interest rate of the loan for different securities and assets and choose the one available at the lowest interest rate.
Also compare the interest rate of the loan with the return on assets. As a rule, it makes sense to liquidate the assets if the interest rate on the loan is higher. But maybe not for all assets.
Sanctions may be imposed prior to the liquidation of the assets. In the case of insurance, for example, the insurance costs are generally high in the first years after purchase. In this case, it may be better to get a loan against a policy, even if you think that the interest on the loan is higher than the return on the policy. Do a cost-benefit analysis to find out.
Similarly, if you make a fixed deposit from ₹10 lakh and you only need ₹1 lakh for a short period of time, you risk paying a higher fine for violating the entire AD. In that case, it may be better to obtain a loan guaranteed by the DF.
As far as equities and investment funds are concerned, there is no point in liquidating them if the markets are collapsing and your investment has lost a lot of value in its current form. Instead of selling your MF or shares at a loss, consider taking out a loan and keeping your shares. Keep in mind, however, that it is impossible to obtain a loan against shares of all companies or investment funds. Usually banks and credit institutions have their own list of companies and investment fund programmes for which they offer loans.
With all this in mind, remember that these loans can only help you if you need money for a short period of time. It is preferable to grant collateralised loans only in the event of a short-term financial crisis. Remember, this is where you make your investment. The bank can seize your DF or investment fund in the event of non-payment, according to Shetty.
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Graphs : Pepermunthof
Also pay attention to the conditions of these loans. Take the case of the life insurance loan. If the interest (amount) on an insured loan exceeds the cost of repaying the loan, you are no longer eligible for insurance coverage under the policy, Mrs. Shetty said. In other words: Your insurance payments under the policy may be temporarily suspended. It may be in your interest not to jeopardize your insurance coverage in these difficult times.
Although some experts advocate securities lending in certain circumstances, they suggest that securities should be sold rather than borrowed, which is not very important for some. It is always better to liquidate investments than to borrow, especially in the current scenario where the markets have fallen, the recession is coming, you have uncertainties for tomorrow, etc., said Taresh Bhatya, an investment advisor registered with Sebia and a partner of Advantage Financial Planners LLP.
Bhatia added that as a last resort one can take out a loan against gold or real estate. These assets have a high transaction value, so their liquidation may be unnecessary. In fact, taking out a mortgage on a property can be the best option because you can continue to use the property even if you have a mortgage on the property. A home loan is the best option because it is available at the lowest interest rate compared to other methods, says Mana Pandey, director of Mainstream Investments Advisors Pvt. Ltd, a financial planning and asset management company based in Delhi.
It is important to select a property carefully and remove it as soon as possible, Pandey added.
The overall decision must be based on the amount and duration of the loan you want, the return of the securities, the penalties and costs associated with the repayment or remission, and your ability to pay.
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