If I take out a loan against shares, will I still get dividends?

Taking a loan against shares is a common way to access liquidity without selling your investments. However, many investors wonder what happens to the dividends from these shares when they use them as collateral. This article will explore the impact of taking a loan against shares on your dividends, how the process works, and what you need to consider before opting for such a loan.

The Basics of a Loan Against Shares

A loan against shares (LAS) is a secured loan where your shares are used as collateral. Financial institutions offer this type of loan, allowing you to borrow money based on the value of your shares without having to sell them. The loan amount typically ranges from 50% to 80% of the market value of the pledged shares, depending on the lender's policies and the quality of the shares.

This type of loan is popular among investors because it allows them to access funds while retaining ownership of their shares, which may appreciate or provide dividends over time.

What Happens to Dividends?

When you pledge your shares as security for a loan, you give the lender a lien on the shares rather than giving them ownership of the shares. This means that the shares are still in your name, and you retain all the rights associated with them, including the right to receive dividends.

Indeed, even if you have taken out a loan on your shares, you will still get dividends on them. The dividends are deposited into your account as they would be if the shares were not pledged.

How Are Dividends Handled?

The dividends are typically credited to your bank account linked with your Demat account. The lender does not have any claim on the dividends, as they only hold the shares as collateral for the loan. However, it is essential to note that while you receive the dividends, the shares are blocked from being sold or transferred until the loan is repaid.

In some cases, lenders may require you to use the dividends to pay off part of the loan or the interest accrued. This condition should be clearly outlined in the loan agreement, so it is crucial to read and understand all the terms before proceeding with the loan.

Impact on Your Financial Strategy

Receiving dividends while having a loan against shares can be a significant advantage, especially if the dividends are substantial enough to cover the interest payments on the loan. This situation allows you to maintain your investment and enjoy the income it generates while also having access to liquidity.

However, relying on dividends to cover loan costs can be risky. Dividends are not guaranteed and can be cut or eliminated by the issuing company at any time, depending on their financial performance. If you are dependent on these dividends to service your loan, any reduction or suspension of dividend payments could put you in a challenging financial position.

Risks Involved

While the ability to retain dividends is a benefit, taking out a loan against shares does come with risks:

1. Market Volatility: The value of your shares can fluctuate due to market conditions. If the value of the pledged shares drops significantly, the lender may issue a margin call, requiring you to either pledge additional shares or repay part of the loan. Failure to meet the margin call could result in the lender selling your pledged shares to recover the loan amount.
2. Interest Payments: The interest on a loan against shares is typically lower than that of an unsecured loan but can still be substantial. If the dividends are insufficient to cover the interest payments, you will need to pay the difference out of pocket, which could strain your finances.
3. Opportunity Cost: By pledging your shares, you lose the ability to sell them during market highs, potentially missing out on profit opportunities. Additionally, if the shares appreciate significantly, you may regret having them tied up as collateral.
4. Debt Accumulation: Taking a loan against shares can lead to debt accumulation if not managed carefully. If the loan is not repaid on time, it could lead to financial strain, and you might have to liquidate your investments at an unfavorable time to settle the debt.

Things to Consider Before Taking a Loan Against Shares

Before deciding to take out a loan against shares, consider the following:

1. Loan Terms: Carefully review the loan terms, including the interest rate, repayment schedule, and any clauses related to the use of dividends. Ensure that the loan is affordable and that you have a solid repayment plan.
2. Market Conditions: Evaluate the current market conditions and the potential for your shares to maintain or increase in value. Consider the risk of a margin call and whether you are prepared to meet it if necessary.
3. Alternative Options: Explore other financing options that may be available to you, such as personal loans, which do not require collateral. Make sure you consider the advantages and disadvantages of each choice before choosing one.
4. Long-Term Financial Goals: Consider how taking a loan against shares aligns with your long-term financial goals. If the loan allows you to achieve a significant financial objective without selling your investments, it may be a good option. However, if it jeopardizes your financial stability, it may be worth reconsidering.

Conclusion

Taking a loan against shares can be a useful financial tool that allows you to access liquidity while continuing to earn dividends. However, it is crucial to understand the risks involved and ensure that you have a clear plan for managing the loan and maintaining your investments. By carefully evaluating your options and considering the potential impact on your financial strategy, you can make an informed decision that supports your long-term financial goals.