Personal loan vs loan against shares: Which is better?

Kolkata: With rising pace of life, one can easily need funds all on a sudden. Personal loan is one instrument that is specifically designed for these situations. There is another rote to quick cash -- Loan Against Securities or loan against shares. Both offer quick liquidity but they have differences too -- in costs involved, attendant risks and eligibility. Which one to opt for is a question that is rooted in one's investments, financial situation, financial goals, immediacy of the need etc. Let's have a comparative study of the two avenues.

A personal loan is a typically unsecured loan which is sanctioned without any collateral. The two key factors to decide it are the income level and credit score of the applicant. They carry a declared rate of interest, usually floating, and the money can be used for any end-use -- consumption, travel, education, or even picking up wedding expenses.

A loan against securities is, on the other hand, a secured loan. It is obtained by the applicant pledging shares (or mutual funds) as collateral. For our purpose, let's focus on loans against shares. Such loans are extended as a percentage of their market value. The shares are held by the bank as long as the loan is not fully repaid. The only point is one has to have a sufficient number of shares so that their value exceeds the amount of the loan by a comfortable margin (the extent of which is stipulated by the lending institution).

The rate of interest also varies in the two types of loans. While personal loans are the most expensive types of retail loans and bear (annual) interest rates of 9.99%–25%, the interest rates for loans against shares is about 9% and 11% since secured loans have lower interest rates.

Personal loans are sanctioned in a space of 24–48 hours, since there is nothing to verify. But secured loans take a bit longer so that the lender carries out a due diligence of the shares pledged for the loans.

Therefore, the EMI will be higher for a personal loan. For the lender, loans against shares carry a bit of risk since the value of shares can erode if the market fluctuates. Therefore, lenders typically lend a significantly smaller amount than the market value o the shares ats the time of application.

The application/disbursement for this type of loan is fast and it makes it an ideal instrument for urgent financial needs like a medical emergency. The interest rates are lower since it involves collaterals. The borrower can access funds without having to sell one's investments. The payment terms are often flexible as they offer overdraft facility. Moreover, if one deploys the funds to invest in business expenses, the interest may be tax-deductible.

It involves market risk and margin calls. If the value of the pledged shares drops significantly, the lender can issue a margin call, which requires the borrower to pledge more securities or repay part of the loan to maintain the predetermined loan-to-value ratio. If one sails to meet margin call requirements or defaults on loan payments the lender can sell the pledged securities to sell the shares to recover dues. Also if one opts for overdraft facilities, interest will continue to accrue over time.