When I approached bank for taking loan for the first time, the loan manager discussed different financial terms like security, collateral, mortgage, Lien etc. Frankly that time these all terms were alike for me as I was not aware what is the difference between these terms and how it matters in my loan request. So I decided to have a clear understanding of all these terms to make right decision. So lets have a look what all I gathered for myself and for my readers. Lets first start with the difference between collateral and security.
Earlier when farmers use to approach mahajans for loan, they had to pledge there land as security to the lender. The same happens now, whenever we approach banks for the loan requirement they ask to pledge collateral or security for the loan. But what is the difference between these two terms?
Before moving to understand the difference between collateral and security lets first understand the need for this. While taking loan borrower commits to repay the loan amount with interest in time but to ensure the amount paid as loan will be recovered, lender takes an asset as security from the borrower which ensures there will be no losses in case borrower defaults.
Loan Against Collateral
Collateral is an asset owned by the borrower which act as a guarantee against the loan amount borrowed. In simple words, collateral is an asset which borrower pledge to the lender as a security against the loan. In case borrower failed to pay back the loan amount to the lender, lender can sell the asset to recover his loan amount hence reduces the risk of lender.
The assets that can be pledged as collateral can be automobiles like car or bike, real estate like housing or commercial property, cash accounts, investments, insurance policies, valuables and collectibles,or future payments. Lender can grants loan amount equivalent or less than the value of the collateral depends upon the type of collateral. If borrower pledge market link investment as collateral than borrower may grant only 50 to 60% of the investment amount as loan. This will improve the chances of getting the loan amount back even if investment lose value.
Loan Against Security
Like collateral loans there are some loans which can be taken by pledging securities such as bonds, stocks, futures, forward, options etc. In this security based lending, borrowed pledge his securities portfolio as as guarantee against the loan amount borrowed. In such case borrower can take the interest amount, bonus, dividends, capital gains etc. but not allowed to trade securities.
Each bank decides what all securities can be pledged against the loan. The loan amount that bank gives against the stock portfolio ranges between 50 to 80% of the value of the portfolio. Bank will issue a current account from which you can withdraw money and you will be charged interest only on the amount you withdraw.
In case of borrower defaults on the loan, lender can sell his portfolio to recover the amount of loan.
Some banks accept shares in physical form whereas some accept in dematerialized form.
Features of Loan Against Security
- Loan against security is good to fulfill short term financial need.
- The interest rate on loan against security depends on the prevailing rate in the market.
- Borrower can spend the money borrowed the way he wants to.
- The minimum amount of a loan against securities is Rs 1 lakh while the maximum amount is Rs 20 lakh (in case of dematerialized shares) and 10 lakh in case of physical shares.
- Value of security are valued every week to see the maximum limit of loan available to you.
Collateral loan vs. Security loan
- Collateral are more stable than securities due to which the value of collaterals does not fluctuate as frequently as the value of securities which makes securities more risky than collateral for the lender.
- Collateral can offers higher loan amount whereas the maximum loan amount on securities can be Rs 20 lakhs.