You may be surprised that you can withdraw money without selling the shares you own. Usually, when money is needed, investors raise cash by selling shares in their portfolio. But there is also a provision to take loans from banks and financial institutions by pledging the same shares without selling the shares. This is known as share mortgage loan.
Let's say you own 1000 shares of a company and its price in the market is Rs 500 per share. According to this, the total market value of your shares has become 5 lakh rupees. Now, if you need 2 lakh rupees immediately, you don't have to sell shares for that. If the bank accepts, the loan can be taken by pledging the shares.
But the bank will not give a loan of Rs 5 lakh if the shares are pledged for Rs 5 lakh. Banks and financial institutions value the shares to be pledged and provide loans only up to a certain ratio. How much loan is available depends on the share price, related company, market conditions, Nepal Rastra Bank's system and related bank's credit policy.
When the shares are pledged in this way, the said shares are not sold to the bank. The shares remain in the investor's name, but the bank's lien on them remains until the loan is repaid. After paying off the loan, the bank releases the mortgage. One of the major advantages of share mortgage loans is that you don't have to sell your long-held shares when you need immediate cash. For example, an investor who bought a share at Rs 200 per share has now reached Rs 500 and expects it to increase further in the future. In such a situation, if you need money for some time, instead of selling shares, you can take a loan by mortgaging the same.
But its risk is also linked with the stock market. Suppose, the market value of the mortgaged shares at the time of taking the loan was Rs 5 lakh. After some time the market fell and its price fell to Rs 3 lakh. Even if the share price decreases, the amount of loan taken from the bank does not decrease. This leads to a lower value of the mortgage compared to the loan. In such a case, the bank may ask the borrower to put up additional shares or other acceptable collateral, or to maintain the required ratio by paying some amount of the loan. If the necessary conditions are not met, according to the agreement and the applicable regulations, the bank may sell the mortgaged shares and collect the loan.
Therefore, after taking a share mortgage loan, investors should not only look at the possibility of the share price increasing. You should also consider whether you can provide additional collateral if the market declines significantly. On the other hand, while trying to take advantage of not selling the shares, the cost of the loan cannot be forgotten. Interest and other charges have to be paid on the amount taken from the bank. Therefore, only after calculating both the profit from the increase in share price and the interest and charges incurred on the loan, the actual profit will be known.
A more risky situation is to take a loan by mortgaging the shares you own and reinvesting the same amount in the stock market. As the market grows, it can increase both the size of the investment and the potential returns. But if the market falls, the value of both the pre-existing mortgage shares and the shares purchased with the loan may decline, while the bank's principal and interest obligations remain.
Therefore, it is better to understand the share mortgage loan as an option to get money by selling the shares, rather than understanding it as a system of taking a loan from the bank by securing the shares you have. Used correctly, it can help raise needed cash immediately without having to sell shares, but this same loan can also create additional financial pressure on investors when the market is down.