You need cash in a hurry and consider selling part of your equity holdings. But there is a nagging feeling. The stock market is raging and every index slide is followed by a fresh rise. It may be a good time to sell some of my holdings, you tell yourself. Again, you want to hold on to some shares because you know the price will go up.

You decide to take a personal loan at a high interest rate or use your credit card and ruin yourself at 30-36 per cent.

Think again. You can leverage your stock holding and pledge them for a loan. However, if you are planning to play the markets with the money, be careful. This has spelt doom for many.

Retain your rights

The best part of pledging shares is that you get to retain your right over them, which means you receive all dividends and bonus shares, and have the right to split your stocks. You can even sell the shares that are pledged by leveraging other stocks against them.

The loan?s an overdraft

And even better, the loan comes as an overdraft facility. You are not charged any interest if you choose not to avail of this facility. And if you do borrow, you are charged interest only for the duration that you have used the funds.

Each bank has its own approved list of securities, which it accepts as collateral. The criteria depends on the bank?s internal risk approval systems.

The loan depends on the total value of the shares pledged. And since the market is volatile, their value will rise or fall. So, if the value of pledged shares fall, the overdraft limit automatically comes down.

Let?s see how it works. Suppose, X company?s share is quoting at Rs 2,500 apiece and you pledge 1,000 shares. Your loan limit will be 50 per cent of the total value of the shares, which is Rs 12.5 lakh. If you borrow up to the limit and the price falls to Rs 2,250, your overdraft limit falls to Rs 11.25 lakh, which means you will have to repay Rs 1.25 lakh.

Close watch

As stock price movements are volatile, banks review the portfolios of the borrowers every one or two weeks, whereby they compare the market value of securities pledged and readjust the overdraft limit.

One question to ask before pledging your shares is the time the bank will give to meet any shortfall in the overdraft limit. Most banks charge 1-2 per cent of the loan amount as penalty, if you are unable to meet the shortfall.

Rate roster

Interest rates range between 11 and 16 per cent depending on the bank and your credit profile and the amount of overdraft. There is no pre-payment penalty.

However, since it is an overdraft facility, the interest is calculated in the following manner. You pledge shares to avail of a Rs 2-lakh overdraft for 3 months and the bank charges you 12 per cent as interest. But ultimately you need the money for just 45 days. Your total interest cost will be Rs 2,959, which means that you pay interest only for those 45 days and not for three months, which would have been Rs 5,918.

A final word: Try not to borrow to the maximum extent allowed. That way, if the price of your pledged shares dips, you will not have to rush to repay any over-borrowed funds. And always borrow against those shares which you do not want to sell.