In mutual fund investment, it has been observed that a significant portion of investors in equity mutual fund schemes do not adhere to their investments for extended periods. According to AMFI data, only 54% of retail investors maintained their equity fund investments for over 2 years in 2020.
What is a loan against mutual funds?
A loan against mutual funds is a method of borrowing money using mutual fund investments as collateral. Instead of liquidating your funds, you borrow against their value. This enables you to access cash without selling your investment and potentially missing out on future growth, while still necessitating repayment of the loan with interest.
Essentially, this functions as an overdraft facility where the bank/NBFC sets a specific limit (based on the value of your mutual fund units) up to which you can borrow for a specified time (usually up to 1 year). This operates akin to a pre-approved loan, with interest charged on the borrowed amount and tenor.
Since these loans are secured against your mutual fund units, the lender has a lien or right on the units. When you pledge your mutual fund units to avail of the loan against them, the investment continues to earn returns. This is because the mutual funds serve as security, and the right to sell off these units can only be exercised in the event of default on the loan.
Features of loan against mutual funds
- Individual investors, NRIs, firms, HUFs, trusts, companies, and entities can avail of loans against mutual fund investments. Minors are not eligible.
- The loan amount you receive depends on the type of mutual fund (Equity/Debt/Hybrid) and the bank/NBFC from which you avail this facility.
- The average interest rate charged for a loan against mutual funds ranges from around 9% to 11%.
- The loan amount can range from a minimum of Rs 25,000 to a maximum of Rs 5 crore, depending on the bank or NBFC.
Advantages of loan against mutual funds
Loans secured by mutual funds offer a convenient means of accessing cash without liquidating your mutual fund investments. This allows you to tap into the value of your investments while still allowing them to grow over the long term.
The process of obtaining these loans is swift and efficient. Whether you need funds for an emergency or a planned expense, you can typically access the capital you need relatively quickly compared to traditional loan processes.
One of the key advantages of these loans is the competitive interest rates often offered by financial institutions. These rates are typically lower than those associated with other forms of debt, such as credit card balances or personal loans, making them an attractive option for borrowers seeking cost-effective financing.
Importantly, borrowers continue to benefit from the potential growth and dividends generated by their mutual fund investments even while the loan is outstanding. This means you can still earn returns on your investments while using the borrowed funds for other purposes.
Disadvantages of loan against mutual funds
Despite their advantages, loans secured by mutual funds come with certain risks and limitations. One significant risk is the potential for the value of the pledged mutual fund units to decline. If the value drops significantly, borrowers may face margin calls, requiring them to either repay more of the loan or provide additional collateral.
Margin calls can create financial strain for borrowers, especially if they are unable to meet the lender’s requirements. Failure to respond to margin calls or adhere to the repayment schedule could result in the lender liquidating mutual fund units, leading to capital losses and potential tax implications for the borrower.
To mitigate these risks, lending institutions often impose caps on the amount that can be borrowed, limiting loans to a specific percentage of the mutual fund’s value. While this helps mitigate risk for both borrowers and lenders, it also means that borrowers may not be able to access the full value of their investments through these loans.
Additionally, borrowers should carefully consider whether the potential returns from their mutual fund investments outweigh any additional costs associated with the loan, such as interest payments and fees. Conducting thorough research and due diligence can help borrowers decide whether these loans are the right choice for their financial needs.
Conclusion
In conclusion, a loan against mutual funds offers a practical solution for accessing funds without liquidating investments, allowing investors to leverage the value of their mutual funds while still benefiting from potential growth. While these loans provide convenience and competitive interest rates, they also come with risks, such as potential declines in the value of pledged units and margin calls.
Thus, borrowers should weigh the advantages and disadvantages carefully and conduct thorough research before opting for this financial tool to ensure it aligns with their long-term financial goals and risk tolerance.
Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions.
