How do loans against shares work, and should you get one?

First, let’s find out how you can get such a loan.

How to get a loan against shares

The process begins with completing a one-time KYC with the lender using your PAN and Aadhaar details. If your Aadhaar is linked to your mobile number, the required information is fetched automatically through DigiLocker.

Once the KYC is done, shares are pledged using the depository participant (DP) ID, and the DP sends a confirmation once the pledge is created. Note that pledging shares is permitted only on working days.

Your bank account will then be verified online through an e-mandate, after which you must read and digitally sign the loan agreement to complete the process.

How big a loan you can get?

By pledging your shares, you can avail an overdraft facility from the lender. An overdraft facility is a flexible line of credit that allows a borrower to withdraw funds up to a pre-approved limit, with interest charged only on the amount actually used and for the period it remains outstanding.

RBI rules stipulate a maximum loan-to-value (LTV) ratio of 50%. For example, if your pledge shares worth ₹8 lakh, you can get a loan of up to ₹4 lakh. If the lender offers the maximum permissible LTV ratio of 50%, the biggest loan you can get is ₹1 crore (by pledging shares worth ₹2 crore).

"Banks can offer up to ₹1 crore as a loan against shares to an individual, while non-banking financial companies have no such limit," said Kapil Nagpal, a member of the founding team of Volt Money.

It's important to know that the LTV ratio varies depending on the quality of the shares pledged. “Loan-to-value ratios vary across lenders. Large-cap stocks usually qualify for the maximum permissible LTV of 50%. For small- and mid-cap stocks it could go down to as low as 30%," said Ravi Doshi, business head-secured loans at Mirae Asset Financial Services (India).

Mirae Asset Financial Services, for instance, has a base LTV of 45% to build in an extra margin of safety, with further adjustments depending on the quality of the stocks. Although the RBI allows an LTV of up to 50%, lenders may set lower limits to manage risk.

Also, not all stocks are eligible for a loan against shares. Lenders maintain their own approved list of stocks that be pledged as collateral.

What if the value of the shares drops?

If the prices of your stocks drop, it can push the LTV ratio beyond the 50% threshold. Say you have an outstanding loan of ₹4 lakh against ₹8 lakh worth of shares and the value of the shares drops to ₹7 lakh. The LTV ratio climbs to 57%.

To restore it to 50%, you have two options — reduce the loan amount or pledge more shares. Reducing loan would require you to pay ₹50,000 to bring the outstanding value down to ₹3.5 lakh – 50% of the new share value of ₹7 lakh. The other option is to pledge ₹1 lakh worth of shares to restore the equity cover to ₹8 lakh. This LTV revaluation is done daily.

“For small investors with limited holdings, this can become cumbersome, particularly during volatile market phases, as sharp price swings can frequently push the LTV close to or beyond prescribed thresholds," said Vinayak Savanur, a Sebi-registered investment advisor and founder of Sukhanidhi Investment Advisors.

What are the repayment terms?

A loan against shares is usually sanctioned for one year, with some lenders allowing it to be rolled over for a fee. Unlike conventional loans, it does not involve EMIs that combine principal and interest. Borrowers are instead required to service only the interest each month.

For instance, if you draw ₹4 lakh at an annual interest rate of 10%, the daily interest works out to about 0.03%, or roughly 0.85% for the month. This translates to a monthly interest of around ₹3,400.

Once the principal is fully repaid, the pledged shares are released and no further interest accrues. Most lenders charge interest rates of 9-12%.

Can you lose your shares?

Yes, there are situations in which you can lose your pledged shares. If the loan-to-value ratio breaches the permitted limit—50% or a lower threshold set by the lender—and the shortfall is not corrected within the stipulated deadline, the lender can sell the pledged shares to recover the outstanding amount.

For example, let’s say the pledged shares initially valued at ₹8 lakh drop to ₹7 lakh, reducing the eligible loan limit to ₹3.5 lakh from ₹4 lakh. If the borrower has already drawn ₹4 lakh, the excess ₹50,000 becomes overdue. If the borrower fails to reduce the loan or pledge more shares within seven days, the lender can sell shares worth ₹50,000 to cover the shortfall. If the LTV touches 60% or higher, the lender can liquidate the shares immediately, without having to wait seven days.

Lenders can also liquidate the pledged shares if the borrower defaults on interest payments for 60 to 90 days, depending on the terms and conditions of the loan.

Should you get this loan?

Financial planners say loans against shares are advisable for short-term requirements. “We typically advise clients to use this for short-term needs, especially when the requirement is for less than a year. In such cases, a loan against shares can be a practical alternative to selling equities, which would otherwise trigger capital gains tax and break the long-term compounding benefit of staying invested in stocks," said Surya Bhatia, a financial adviser at Asset Managers.

“However, it is not advisable as a long-term solution. Equities can go through bouts of volatility, even when the portfolio is largely tilted towards large cap stocks. Extending an LAS for longer periods also means that interest costs steadily eat into overall equity returns," he added.

Use this option sparingly, and only for short-term loans. Avoid using the maximum LTV as it can lead to frequent margin calls when markets are volatile, requiring you to pledge more shares or reduce the loan outstanding to avoid losing your shares.