There are several loan instruments available in the market and each of them has different characteristics and suitability. Now, from the point of view of the obligation to pledge collateral against a financing facility, loans can be divided into two categories: unsecured loans and secured or guaranteed loans. Both have their own set of benefits.
In this article, I will focus on the different types of secured loans involving securities like gold, stocks, term deposits, insurance policies, cars, property, etc. to help you make informed fundraising decisions.
Features and Benefits of Secured Loans
You can get unsecured loans which would eliminate the requirement of having to give collateral against it, but they usually come at a higher cost. The interest rates and fees on a secured loan could be lower than on an unsecured loan such as a personal loan. The pledge of security like gold, stocks, mutual funds, etc., protects the lender against the possibility of default by the borrower. Since the borrower could liquidate the asset to recover its contributions, the risk premium on the interest of the loan decreases considerably.
In a secured loan, the borrower may also have more flexibility compared to an unsecured loan, such as the option of a longer repayment term and a higher loan amount with lower interest. . That being said, the loan amount will depend on the value of the security pledged – the higher the value, the larger the loan you could take against it, and vice versa. In addition, pledging collateral in a secured loan reduces reliance on the borrower’s credit rating; which means that if a borrower has a bad credit rating, they may not qualify for an unsecured loan, and even if they do, they are likely to get a higher interest rate on the loan ; therefore, applying for a secured loan could be a much better financing option for him.
There are different types of secured loans available in the market, and you can select the appropriate loan product depending on the size of the fund required, the term for which you need the loan, the type of asset you can put. pledge and interest. rate applicable on it. Let us examine the different secured loans and their features.
1. Gold loan
If you are short of cash, you can unlock the value of your unused gold jewelry or gold coins (with a minimum purity of 18 karats) in a locker to use as collateral in order to obtain a loan against it to meet your cash flow needs. Banks and financial institutions generally allow a loan of up to 75% of the current market value of the pledged gold, subject to the lender’s loan amount threshold. Interest rates generally vary between 7.5% and 15% per year depending on the loan amount, the term and the policies of the lender. While some lenders also charge a processing fee (usually 0.25 to 1% of the loan amount), others do not charge such a fee. A gold loan could be an attractive option for those who have gold with them and the need for a loan is not huge.
2. Loan against securities such as mutual funds / stocks / bonds / FD
You can also get a loan against your investments like mutual funds, stocks, bonds, etc. Usually, banks allow a loan-to-value ratio (LTV) of up to 50% when the loan is against market-related securities such as stocks and mutual funds. But the LTV for Kisan Vikas Patra and non-convertible debentures (NCDs) is higher at around 80% while it could be 90% for term deposits. You can use loans against your long-term investments in stocks, mutual funds, and bonds to meet your short-term fund needs. Interest on securities loans depends on the type of underlying securities and the amount of the loan. For example, in loans against DFs, banks typically charge a spread of 1-2% on top of the interest on DFs offered as collateral.
3. Loan against car
If you are looking for a loan and don’t want to pledge your investments, a loan against your car may be a good option. Banks usually allow an LTV of around 50% of the car’s estimated value, but some lenders allow a high LTV of up to 150% of the car’s value. The loan amount depends on the make, model, year of purchase and condition of the car. Interest on these loans is generally higher than loans against securities or gold. Having said that, it can still be a great instrument for borrowers who have no other options to put as collateral.
4. Loan against insurance policy
If you have a traditional life insurance policy like an endowment plan, you can use it as collateral to get a loan. Banks take into account the paid-up value, not the sum insured, of the insurance policy to estimate the maximum allowable loan amount to a borrower. Loan Against Insurance is suitable for borrowers who want a long term and are looking for a low interest option. Banks allow an LTV of up to about 90% on a life insurance policy loan. However, you must maintain a policy for at least 3 years to make it eligible as loan security.
5. Loan against property
If your need for a loan is high and you are looking for a very long repayment term, the loan for property could be a great financing option. Banks typically allow an LTV of 60-65% for these loans and the interest rate is around 7-10% per annum depending on the loan amount and duration, among other factors.
Essentials to keep in mind before applying for a secured loan
Secured loans are a very interesting borrowing tool provided you select the one that best meets your needs. For example, if you need large funds, instead of using a lot of collateral, you can secure a high-value asset like your property or life insurance plan to get a consolidated loan at a lower rate. Also, avoid securing a high value asset for a low value loan. In securities lending, the borrower is required to maintain a mark-to-market margin, and failure to do so may trigger a liquidation of the collateral by the lender. Thus, borrowers should avoid large amounts of loans on securities such as stocks and mutual funds when the market is volatile. Also, it might be better to liquidate your profitable mutual fund investments to meet your fund requirements instead of pledging them as loan collateral.
Most importantly, have a full repayment plan before applying for a secured loan, as any default could result in the loss of a valuable asset that could have long-term implications for your family’s financial future, especially if you have promised something as critical as your life. household insurance, property or gold policy to obtain the loan. Finally, always compare your options, including pre-approved unsecured loans, and consider other associated fees like processing fees and prepayment penalties to get the best loan deal.
(The author is CEO, BankBazaar.com)