Cheaper alternatives to unsecured personal loans

While you decide to take a personal loan, often the most confusing thing is what type of loan to go for. So there are two kinds of personal loans: secured or unsecured. To get an unsecured loan, you don’t need to pledge a security, and it usually has a comparably higher rate of interest. Whereas a secured loan comes with a lower interest rate but higher borrowing limits. For such type of loans, you have to secure your assets.

While secured loans like car loan and home loans are straightforward in terms of their objective, some other secured loans like loan against property, shares, and mutual fund can be used for any purpose. Secured loans also differ from unsecured loans  in terms of tenure, amount and interest rates. You can use different types of assets to pledge and raise a loan against it in line with your needs. Recently, a leading private sector bank lender launched digital loans against mutual funds with the ticket size of the loans ranging from Rs 1 lakh to Rs 1 crore at an interest rate of 10.5 -11%.

These segments are seeing good growth according to statistics from the Reserve Bank of India. As per the RBI’s monthly bulletin for May, the year to date growth in loans against FDs was 9.6% and 17% for loans against shares and bonds.

Let’s take a look at each one of the assets that can get us secured loans for any purpose.

Loan against mutual funds

Since mutual funds are assets in your name, you can avail a loan against them. The value of the mutual fund units decide the loan amount and it is usually 60-70% of the value of the mutual fund units pledged at the time of applying for the loan. Once this is done, a lien will be put on the mutual funds by the lender. A lien enables the lenders to recover the loan amount in case of a default by the borrower. After a lien is applied, an investor cannot sell the mutual funds. The interest rate for this loan is decided at the time of application itself.

Loan against equity fund can get you funds up to Rs 20 lakh and up to Rs 5 crore against debt fund depending on the bank’s norms. Banks asks for a margin of around 50% (15% against a debt fund) of the net asset value of the fund. The loan tenure can be enhanced after review at the end of every year. You cannot pledge mutual fund units that comes with a lock-in period.

Keep in mind: Mutual funds can be comparatively less volatile than the stock market, therefore you may not be asked to replenish the margin amount often. You should use loan against mutual fund when the requirement is for short to medium term and the fund requirement is not very high. However, you should not compromise on your investment just for the sake of discretionary spending.

Loan against shares

Loan against shares are usually allowed as an overdraft or demand loan against the eligible list of securities. The bank may ask you to open a demat account at its designated broker branch. Loan is disbursed for personal use except speculative purpose or inter corporate investments. Lenders usually consider a margin of up to 50% of the market value of the scrips to be pledged with the bank. The loan amount ranges between Rs 50,000 to Rs. 20 lakh, but some banks do allow loan amount as high as Rs 10 crore, so doing a research beforehand is advisable.

The main advantage of loan against securities is that you can stay invested in the equities and at the same time you can use the loan raised against it to fulfil your financial requirement. Later, you can repay loan to get your shares freed from the bank.

Keep in mind: The stock market is volatile. If your share value falls significantly, then the bank may ask you to increase the value of a pledged security by pledging more shares or replenish by putting requisite cash funds. So, your loan amount will keep fluctuating with the market volatility.

This should be your last resort for seeking a loan and should be taken only for a short duration. In the long term you may find it difficult to tackle the volatility to manage the margin requirement.

Loan against fixed deposits

Loans against fixed deposits can be a wise choice for availing loans as they are easy to obtain and they come with lower interest rates. Banks grant loan up to 80-95% of the FD amount. Interest on loan against FD ranges from 1- 2% above the underlying FD interest rate. There is no processing charge levied by the banks on the loans against FDs. The loan amount can range from Rs 25,000 to Rs 5 crore or more depending on the bank’s norms. Repayment period is up to five years (or as per the tenure of the underlying FD). You can apply for such type of loan using the online banking platform or by visiting your nearest bank branch.

Keep in mind: The interest rate is linked to the underlying FD rate, so if you renew FD in the future and interest rate increases, then rate of this loan will also go up simultaneously. LAFD is suitable when you are under sudden financial crisis as they can be made available quickly without much hassle.

Loan against insurance

You can get loan against an eligible insurance policy through the respective insurance company or the bank by assigning your policy in favour of the lender. Normally banks and insurance companies allow loan in the range of 60-90% of the surrender value of the insurance policy.

Keep in mind: You can apply for a loan against an insurance policy only if the policy has completed three years prior to the loan application. A loan is not allowed against a term policy or Unit Linked Insurance Plan (Ulip). If the interest on the loan against insurance exceeds the surrender value of the loan, then the policyholder may no longer get the insurance cover from the assigned policy. If you have paid a large amount for the insurance policy, and you require low-cost fund for objectives like business or for arranging the down payment on your home, you can use loan against insurance.

The writer is CEO, Bankbazaar.com