Let’s say, you invest in mutual funds, and you need money urgently.
Do you redeem your investments?
What if I tell you that you can avail of a loan from banks against your investment in mutual funds? Even if not all type of mutual fund offers high liquidity, you can still use them as security to get a loan against your investments.
I will cover the ins and outs of taking a loan against mutual funds in this article. Read on.
In this article
Loan Against Mutual Funds
Investing in mutual funds can help you secure capital for future goals as well as expenses.
However, the financial crisis, small and big, can occur to anybody and at any point in time. It often happens that investors require money on short notice.
Most investors are likely to liquidate their mutual funds. But this can adversely impact your investment and financial plan, as you end up with lower returns than anticipated.
A much better option is to take a loan against your investments in mutual funds.
It helps you to access a corpus of funds, without losing out on the ownership of your investment in mutual funds.
Investors of Mutual fund can avail loan against their mutual fund investments easily and it is in the form of an overdraft facility and interest is charged only on the amount availed as credit.
How Does It Work?
Each financial institution will have a list of approved mutual funds against which they will be willing to give loans to the investors.
Investors have to enter into an agreement with the bank and grant ownership of the mutual fund scheme to the bank, which gives the banks the right to sell the fund in case of non-payment of the loan.
Basically, loans against mutual funds allow you to borrow money by parking your mutual fund investment as collateral.
The limit of the loan amount is typically up to 50% of the net asset value (NAV) of the mutual fund units pledged in case of equity and up to 70-80% in case of debt funds.
The application process involves marking of lien on the mutual fund units in favor of the bank or financing institution. Once the lien is marked, the units cannot be sold or redeemed by the investor.
Also, some banks also have a maximum and minimum cap on the loan amount that you can apply for against the mutual funds.
For example, HDFC Bank offers loans of Rs. 1-10 lakh on equity-oriented mutual funds and up to Rs. 1 crore on debt-oriented mutual funds. There is no tenure in an overdraft facility however the loan is renewed annually.
Interest Rates For Loans Against Mutual Funds
As the loan is backed by an asset, interest rates are lower than that of a personal loan and are typically in the range of 10-12% per annum.
Also, if the credit score of an investor is good or he/she has been a longstanding bank customer, the bank manager might agree to lower the interest rate even more.
But remember, this will be subject to terms and conditions set by the financier and loan tenure.
The Process To Apply For A Loan Against Mutual Funds
The loan can be availed through both online and offline modes.
There are many online portals available that sanction loans quickly if you hold units in the Demat form and have prior permission. In case you hold units in the physical form, a loan agreement with the financier or bank should be in place.
Following are steps to be followed to apply for a loan against mutual funds:
- First, a current account is opened with an overdraft facility. The investor can avail the overdraft facility up to the value borrowing limit set for the account on the basis of the collateral mutual fund units.
- Then the investor must fill up the application form for marking a lien providing the details like folio number, scheme name, plan, option and the number of units.
- Once the documents are received, these are forwarded to the mutual fund registrar for lien marking i.e, to mark a lien on the number of units being pledged.
- The registrar then marks the lien and sends a letter to the lender with a copy to the borrower confirming the lien.
An important thing to keep in mind is that the lien is marked against the units and not the amount. So, you cannot redeem the units of your mutual funds before you completely repay the loan to the financier or the bank.
Also, the banks or the financing institutions have a list of approved mutual funds schemes on which they offer this facility.
How To Revoke The Lien?
A lien can be revoked only if the financier or the bank confirms in writing that the lien can be revoked and the collateral be released in favor of the borrower.
Once the loan amount is repaid, the financier or the bank can send a request to the mutual fund house to lift the lien.
Investors can also enforce a partial removal of lien in case the financiers receive part payment. As a result, some units will be freed up and the rest will remain under lien.
The financier or the bank can reinforce the lien if the borrower fails to repay the loan in the duration agreed upon. The same goes for defaulting too.
In such a scenario, the lender requests the mutual fund to redeem the units and send the cheque to the lender.
Benefits Of Borrowing Loan Against Mutual Funds
Mentioned below, are some of the main benefits of taking loans against mutual funds:-
- It is a good way to receive instant liquidity against your investment in mutual funds.
- This is a very good way to quickly raise capital for short-term financial requirements if you think your investment in the mutual fund is lying idle.
- The interest rates for a loan against mutual funds are generally lower than that for personal loan interest rate.
- You do not have to sell your units for a loan against mutual funds and this ensures your financial plans are not altered.
- Though lien is marked on the units, so the investor continues to earn dividends from the units of the mutual fund.
Loans against mutual funds are quite a rare practice in India due to lack of awareness and information on the subject.
So, in a nutshell, next time you think of alternative ways of raising an emergency capital, remember that a loan against your mutual funds can be a better option than other traditional instruments.
Disclaimer: The views expressed in this post are that of the author and not those of Groww.