Introduction:
Life is full of unexpected events, and occasionally, we may find ourselves in a temporary financial crunch for various reasons. Whether it’s a home renovation, a family wedding, or a medical emergency, the immediate instinct might be to dip into our savings or liquidate investments, even if it means incurring losses. However, there is a better alternative to consider – obtaining a loan against your mutual fund investments. Just like pledging other assets such as gold or real estate for a loan, you can leverage your mutual fund holdings to secure a loan from banks and Non-Banking Financial Companies (NBFCs)
What is Loan Against Mutual Funds?
Loan against mutual funds is a popular financing option that allows individuals to leverage their mutual fund investments to meet their financial needs. One of the advantages of a loan against mutual funds is that borrowers can maintain ownership of their investments. There is no requirement to sell the mutual fund holdings, enabling investors to capitalize on potential market growth and long-term wealth creation. By utilizing their existing investments as collateral, borrowers can access funds without interrupting their investment strategy.
Before opting for this type of loan, it’s essential to have a comprehensive understanding of how it works and the key considerations involved. In this article, we will explore the important things you should know about loan against mutual funds.
Secured Loan Against Mutual Funds:
A loan against mutual funds is a secured loan, where borrowers pledge their mutual fund investments as collateral. The value of the loan is determined based on the net asset value (NAV) and the type of mutual funds being offered as collateral. By pledging the mutual funds, borrowers can access funds while retaining ownership of their investments.
Loan-to-Value (LTV) Ratio:
Lenders typically offer a loan amount based on a certain percentage of the mutual fund’s net asset value, known as the loan-to-value (LTV) ratio. The LTV ratio varies among lenders and usually ranges from 50% to 80%. For instance, if the LTV ratio is 60% and the net asset value of your mutual funds is ₹1,00,000, you may be eligible for a loan amount of up to ₹60,000.
Interest Rates and Charges:
Interest rates on loan against mutual funds are generally lower compared to unsecured loans, such as personal loans or credit card debt. The rates can vary among lenders but tend to be competitive. It’s crucial to compare interest rates, processing fees, and other charges before selecting a lender to ensure you get the best deal.
Loan Tenure and Repayment:
Loan against mutual funds comes with flexible tenure options. The repayment period can range from a few months to several years, depending on the lender’s terms and the borrower’s preferences. Borrowers can choose between regular EMIs (Equated Monthly Installments) or opt for the overdraft facility, where they pay interest only on the amount utilized.
Impact on Mutual Fund Investments:
When you take a loan against mutual funds, the pledged mutual funds continue to be invested. However, the loan amount is blocked against the mutual fund units, and you cannot redeem or sell those units until the loan is repaid. It’s important to be aware of this restriction and plan your investments accordingly.
Eligibility and Documentation:
To qualify for a loan against mutual funds, lenders generally require borrowers to meet certain eligibility criteria, including a minimum age, a specified minimum investment in mutual funds, and a good credit history. The documentation requirements typically include KYC documents, proof of ownership of mutual funds, and loan application forms.
Risks and Precautions:
While a loan against mutual funds offers numerous benefits, it’s essential to be aware of the associated risks. If the borrower defaults on loan repayment, the lender can invoke the pledge and liquidate the mutual fund units. Moreover, market fluctuations can affect the value of the mutual fund investments, potentially impacting the loan-to-value ratio.
Loan Closure and Prepayment:
Borrowers have the option to close the loan against mutual funds by repaying the outstanding amount in full. Some lenders may charge prepayment penalties, so it’s crucial to clarify the terms and conditions regarding loan closure and prepayment before availing the loan.
Conclusion:
Loan against mutual funds provides individuals with a flexible financing option, allowing them to meet their financial requirements while leveraging their mutual fund investments. By understanding the key aspects, including the loan-to-value ratio, interest rates, repayment options, and associated risks, borrowers can make informed decisions. It’s advisable to compare multiple lenders, assess the terms and conditions, and choose a loan product that aligns with your financial goals and needs. Remember to consult with financial advisors or experts if you require additional guidance.
