Loan Against Mutual Fund Units: A Borrowing Guide

In an ever-evolving financial dynamic, borrowing loans against mutual fund units has emerged as a convenient and flexible option for investors in India. This method allows individuals to leverage their investment portfolio without liquidating their assets. Understanding how loans against mutual fund units work, their benefits, and potential risks can help you make informed financial decisions. Read this article to learn all about loans against mutual funds in detail.

What is a Loan Against Mutual Fund Units?

A loan against mutual fund units is a secured loan where you pledge your mutual fund investments as collateral to borrow money from a lender. This type of loan provides liquidity without requiring you to sell your mutual fund units. The loan amount you can avail of depends on the value of your mutual fund holdings and the lender’s policies.

How Does it Work?

The process of obtaining a loan against mutual fund units involves the following steps:

1. Application: You apply for the loan with a lender, such as a bank.
2. Pledging: Your mutual fund units are pledged as collateral. This involves a lien being marked on your units, restricting you from redeeming them until the loan is repaid.
3. Approval and Disbursement: The lender evaluates the value of your pledged mutual fund units and determines the loan amount you are eligible for. Once approved, the loan amount is disbursed to your account.
4. Repayment: You repay the loan in instalments, which include both principal and interest. The interest rate is generally lower than unsecured loans due to the secured nature of the loan.
5. Release of Lien: Upon full repayment of the loan, the lien on your mutual fund units is removed, and you regain full control over your investments.

Benefits of a Loan Against Mutual Fund Units

1. No Need to Liquidate Investments: A primary benefit of this type of loan is that you do not need to sell your mutual fund units. This allows you to benefit from the potential growth and returns of your investments while still accessing liquidity.

2. Lower Interest Rates: Since the loan is secured by your mutual fund units, lenders usually offer lower interest rates compared to unsecured loans like personal loans or credit card advances.
3. Quick Processing: Loans against mutual fund units usually have a faster approval and disbursement process, especially if you have an existing relationship with the lender.
4. Flexible Repayment Options: Lenders often provide flexible repayment options, allowing you to choose a tenure that suits your financial situation. Some lenders also offer the option to pay only the interest during the tenure and repay the principal amount at the end.
5. No Impact on Investment Goals: By borrowing against your mutual funds instead of selling them, you ensure that your long-term investment goals remain intact. This is particularly beneficial if your mutual funds are part of a retirement or education corpus.

Key Considerations

While loans against mutual fund units offer numerous benefits, there are several factors you should consider before opting for this financial solution:

1. Loan-to-Value (LTV) Ratio: The loan amount you can borrow is generally a percentage of the value of your mutual fund units. This Loan-to-Value (LTV) ratio varies among lenders but generally ranges from 50% to 80%. It’s important to understand the LTV ratio offered by your lender to gauge the potential loan amount.
2. Interest Rates and Fees: Although interest rates are lower compared to unsecured loans, they can still vary significantly between lenders. Additionally, there may be processing fees, documentation charges, and other costs associated with the loan. Comparing the total cost of borrowing across different lenders can help you find the best deal.
3. Impact of Market Fluctuations: The value of your mutual fund units can fluctuate based on market conditions. If the value of your pledged units falls significantly, the lender may ask you to pledge additional units or repay a part of the loan to maintain the required LTV ratio.
4. Credit Score Impact: While the loan itself is secured, your repayment behaviour can still impact your credit score. Timely repayments will positively affect your credit score, while defaults or delays can have a negative impact.
5. Loan Tenure: Choose a loan tenure that aligns with your repayment capacity. While a longer tenure may result in lower monthly payments, it can also increase the total interest paid over the life of the loan.

How to Apply for a Loan Against Mutual Fund Units?

Applying for a loan against mutual fund units involves a few steps:

1. Check Eligibility: Ensure that your mutual fund units are eligible for pledging. Not all mutual fund schemes may be accepted by lenders as collateral.
2. Choose a Lender: Research and compare different lenders based on their interest rates, fees, LTV ratios, and repayment terms.
3. Submit Application: Fill out the application form and submit it along with the required documents. Such as identity proof, address proof, and details of your mutual fund holdings.
4. Lien Marking: Once your application is approved, the lender will mark a lien on your mutual fund units. This process is usually facilitated by the registrar and transfer agent of the mutual fund.
5. Receive Funds: After the lien is marked, the loan amount is disbursed to your account.

Conclusion

A loan against mutual funds can be a practical and efficient way to access funds without disrupting your investment strategy. By understanding the benefits, key considerations, and application process. You can make an informed decision that aligns with your financial needs and goals. As always, it’s crucial to borrow responsibly and ensure that you can meet the repayment obligations to maintain your financial health.