There are times when an individual suddenly needs money but doesn't want to break their long-term investments. In such a situation, one option is to take a loan by pledging their investments with a bank or financial institution. This type of loan is called "Loan Against Assets" and usually has a lower interest rate than a personal loan.
A large number of people are currently taking loans by pledging assets like FDs, mutual funds, shares, gold, or insurance policies. However, before making this decision, it's important to understand some key aspects associated with it.
Loan-to-Value (LTV) Ratio: The Amount of Loan You Can Get
When you pledge your asset, you get a loan up to a fixed percentage of its total value. This is known as the Loan-to-Value (LTV) ratio.
- Gold: Up to approximately 75 percent of the total value
- Fixed Deposit: 90 to 95 percent
- Shares: Approximately 50 to 60 percent
- Mutual Funds (Debt): 70 to 80 percent
- PPF: Only up to 25 percent
- Insurance Policy: Based on the sum assured or surrender value
This ratio depends on the policy of the bank or institution and the regulations of the Reserve Bank of India (RBI).
Assets That Can Be Pledged for a Loan
Various types of assets can be pledged to take a loan from banks and NBFCs. These typically include:
- Fixed Deposits (FDs)
- Shares or stocks held in a Demat account
- Gold, i.e., gold jewelry or coins
- Mutual Funds (especially debt funds)
- Insurance Policies (mostly endowment policies)
- Public Provident Fund (PPF)
Each asset has a limit, based on which the loan amount is determined. This limit is known as the Loan-to-Value (LTV).
Disadvantages and Risks
Although the interest rates on these loans are low, there are some significant risks associated with them. If the market value of the pledged asset decreases, the bank may demand additional margin or security. If you fail to do so, the bank can also sell your pledged asset.
The value of assets like shares or mutual funds depends on the market. If the market falls, the value of your pledged asset may also decrease, which can create difficulties for you.
Secondly, there is no tax deduction on this type of loan, as is available with home loans or education loans. Additionally, there is a risk of seizure of the pledged asset if payments are not made on time.
How Easy is it to Take a Loan on FD?
Taking a loan on a fixed deposit is considered the easiest and safest option. Banks provide a loan of 90 to 95 percent of the amount, and the interest rate is approximately 1 or 2 percent higher than the FD interest rate.
In this, your principal investment remains secure, and if you repay the loan on time, your FD is not affected. It is also offered as an overdraft facility.
Loan Terms on Insurance Policies and PPF Differ
To take a loan on an insurance policy, the policy must be an endowment or traditional policy. Loans cannot be taken on term plans. Insurance companies generally provide loans based on the surrender value.
Meanwhile, the loan facility on PPF is available only between the third and sixth year of the account. The amount is also limited in this and the interest rate is based on government regulations.
Things to Consider When Taking a Gold Loan
The process for gold loans is also simple, and loans are available in less time. However, it is important to note that if the amount is not repaid within the stipulated time, the bank can auction your gold.
Additionally, some institutions charge extra fees like processing fees, storage charges, and insurance, which affect your total cost.
Loans on Shares and Mutual Funds Can Be Risky
Taking a loan on shares or equity mutual funds is a bit risky because their prices depend on market movements. In case of a market decline, a margin call can come from the bank, meaning you will have to provide additional security.
Banks provide loans only on certain shares and have a selection list. In such a case, it is necessary that you check whether your shares or funds are on that list or not.
