Investors usually find themselves at the stage where they need liquidity but do not wish to dispose of long-term investment. Loan against bonds is a good method of mobilization of capital without disinvesting. The facility allows bond holders to realize their investment and yet retain title and enjoy any potential capital appreciation and pay out of interest.
Understanding Loan Against Bonds
Loan against bonds is a secured loan where investors use their bonds as collateral to borrow money from institutions or banks. The loan amount would be based on the market value of the bonds and the loan-to-value (LTV) ratio of the institution. Institutions advance 70-80% of the bond cost as an industry standard.
Advantages of Loan Against Bonds
1. Retain Ownership of Investments
One of the greatest advantages of a loan against bonds is that investors won’t have to redeem their bonds to meet short-term cash requirements. They are able to generate interest income on an ongoing basis while using the loaned amount for business or personal purposes.
2. Reasonable Loan Against Bonds Rate of Interest
Banks provide a relatively lower loan against bonds rate of interest as opposed to unsecured loans. As the loan is secured by offering the bonds as collateral, banks consider it a risk-free method of borrowing with competitive interest rates. Borrowers benefit from favourable terms due to the secured nature of the transaction.
3. Hassle-Free and Quick Process
All the lenders offer instant loan sanction with less documentation. In case the bonds are demat in the same bank, then the loan sanction process is even faster.
4. No Impact on Investment Appreciation
Sale of bonds for capital raising can imply giving up future earnings from capital appreciation and interest income over a period. Through borrowing on bonds, investors can hold onto their bonds and see appreciation in the future.
5. Flexibility of Repayment
Various repayment schedules are provided by lenders, for example, payment of interest plus principal repayment upon maturity. The flexibility provides an opportunity for the investor to coordinate their finances without straining their finances.
How a Loan Against Bonds Works
Step 1: Application Process
Investors can obtain a loan against bonds from NBFCs, banks, or financial institutions which offer the facility. Procedure is to submit preliminary documents like bond details, address proof, and identity proof.
Step 2: Evaluation and Penalty
The lender studies the market price of the bonds and determines the rate of interest for loan against bonds depending on creditworthiness, type of bond, and tenure. Bonds of government and blue-chip companies receive comparatively better treatment under most circumstances.
Step 3: Loan Disbursal
The loan proceeds are credited into the account of the borrower once approved. The bonds are collateralized with the lender until full repayment of the loan.
Step 4: Repayment and Closure
Prepayment, bullet repayment, or EMIs at agreed terms can be permitted to the borrowers to repay the loan. The lender redeems the collateral bonds at the final repayment.
Factors Affecting Loan Against Bonds Rate of Interest
Interest charge on loan against bonds is determined on the below parameters:
- Kind of Bonds: Low-risk government and corporate AAA-rated bonds are offered lower interest rates.
- LTV Ratio: Higher loan-to-value ratio may result in slightly higher interest rates.
- Credit Score: Persons with a good credit score are offered lower interest rates.
- Loan Tenure: Lower tenor loans are offered lower interest rates compared to higher tenor loans.
- Lender Policies: Different finance companies have different interest rates according to the risk study along with lending policy.
Who Should Take a Loan Against Bonds
Investors With Immediate Liquidity Requirement
Those who are faced with sudden need of money without any concept of selling their long-term investment.
Businessmen & Entrepreneurs
Those who require money for business growth without selling their investment.
Retirees on Fixed Income Bonds
Retirees with bonds can use them for day-to-day expenses with periodic interest accumulating on them on a rolling basis.
HNWIs & Institutional Investors
Institutions and high-net-worth investors can make use of this facility for efficient liquidity management.
Other Advantages of Loan Against Bonds
1. No Prepayment Penalty
Prepayment of the loan is usually feasible in most banks without any additional cost. The borrowers can prevent interest charges if they have surplus funds with them prior to the date of the loan period using this facility.
2. Premium Bond Loan Limits Are Higher
The investor’s high-grade bonds such as government bonds or AA-rated business house bonds have higher credit limits when they obtain loans from a bank. They have low interest rates with good LTV values.
3. Suitable for managing the volatility of the market
Investors anticipate a short-term decline in bond prices but do not want to sell their holdings at a loss. Borrowing against bonds can serve as a cushion of funds in the short term. When the market situation improves, they can reimburse the borrowed amount without selling their holdings.
4. Facilitates Portfolio Diversification
Borrowers can invest borrowed funds against a loan on bonds in other investment vehicles, i.e., property, mutual fund, or stock. Borrowers diversify the portfolio without liquidating existing investment in this way.
Risks & Considerations
Even as beneficial as a loan against bonds has turned out to be in many ways, borrowers have to exercise caution to keep an eye out for potential risks:
- Market Fluctuations: Fall in bond prices will influence the LTV value of the loan, and the lenders will initiate margin calls.
- Default on Loan: Default can result in selling of the security by the lender to realize the amount.
- Interest Costs: Less than unsecured lending, but interest costs in terms of build-up over time unless terminated.
- Bond Liquidity: Some bonds are relatively less liquid, and hence the lenders’ inability to sell them when and as needed.
- Margin Calls: In the event of significant drops in prices of bonds, lenders may request additional collateral or prepayment of the loan.
How to Choose the Right Lender?
When taking a loan against bonds, lenders should be compared on the following grounds:
- Interest Rates & LTV Ratio: Compare loan interest rate to bonds and highest amount of the loan.
- Processing Fees & Charges: Processing charge, attorney charges, or other surprise charges are imposed by a few lenders.
- Repayment Flexibility: Select lenders offering flexibility of repayment.
- Customer Support & Speed of Loan Processing: Opt for banks having quick disbursal and better customer care.
Conclusion
Loan against bonds is an excellent financial product that allows investors to borrow liquidity without being forced to sell the investment. With a minimum loan interest rate, minimal documentation, and convenient repayments, the product is ideal for those who can leverage their bond holdings without compromising their financial health. But the borrowers must exercise a wise judgment regarding their repayment capability and market condition while taking such loans so that they do not commit economic folly. The right choice of lender and familiarity with the terms of the loan can help investors reap maximum returns with the least amount of risk.
