Taking a loan against mutual fund investments

Do you know if you invest in Mutual Funds, you can take a loan against Mutual Funds in your urgent short-term requirement of money? Yes, you heard that right!

You have systematically built up a long term MF portfolio comprising of many mutual funds, and they are delivering good returns. Your investment plan gets hampered by redeeming your MF units prematurely to fulfill your short-term financial need and lowers your expected returns. A way out is to take a loan against Mutual Funds.

The process is just like the overdraft facility that the bank offers. You can approach any bank or non-banking financial company (NBFC) to get a loan against your mutual funds. The amount of loan depends on the value of units in the folio and the tenure you choose. You have to pledge your mutual fund investments as collateral to avail of the credit.

What is the interest rate?

Since the loan is secured, the interest rate will be lower compared to any unsecured loan. The interest rate will also be subject to the terms and conditions set by the financier and tenure of the loan. If your credit rating is good or you have a long term relationship with the bank, then the bank manager might lower the interest rate.

What is Lien?

It is essential to avail loan against mutual funds. Lien is the claim that the bank has on the MF units and it gives the right to the bank to sell the fund or hold it. If the borrower fails to repay the loan amount within the stipulated time, the issuer of the loan has the right to use the security howsoever to get the money back.

How and when the lien is revoked?

Once the loan is repaid, the bank or financier can send a request to the fund house to remove the lien. In case the financiers receive part payment, partial removal of lien can be enforced for which some units will be free while the rest would still be under claim.

If the borrower fails to repay the loan timely or becomes the defaulter, the lender can reinforce the lien and make requests to the mutual fund to redeem the units and pay the lender.

A lien is revoked only when the lender gives written confirmation that the claim can be revoked and the collaterals are released in favor of the borrower.

How do you apply?

If you hold MF units in a Demat form and have prior approval, it is quite easy to apply online for a loan with fund units as security. However, in case you hold the fund units in the physical form, you need to apply offline and execute a loan agreement with your financier.

The process involves writing an application by the lender to the mutual fund registrars like CAMS (Computer Age Management Services) or Karvy, to mark a lien on the mutual fund units you pledged. On approval, the registrar then marks the claim and sends a confirmation letter to the lender with a copy to the borrower.

Please note that the lien is always marked against the units and not the amount. Until you completely repay the loan, you cannot sell or redeem the units.

How much loan can you avail?

The amount of loan you get depends on the type of mutual fund you own and it will be lower than the market value of the units held by the borrower known as haircut or margin. For instance, equity-based funds can fetch you around 50% of the Net Asset Value (NAV) of your funds and debt funds up to 75-80% of the NAV. Lenders have a list of approved mutual funds schemes on which they offer this facility and there is a maximum and minimum cap on the loan amount to apply.

What are the benefits?

• Avail instant credit without liquidating your funds and losing ownership of your investment.
• It is a tool to leverage idle mutual fund investments and raise capital for short-term financial need.
• Your Mutual Fund portfolio remains intact and it continues to earn returns and dividends.
• Interest rates are comparatively lower than personal loans.

What are the disadvantages?

• The loan amount is lower than the current market value of the fund units as the losses that might arise considered, given that returns from MF investments are subject to market movement.
• If the financial markets perform well during the tenure of the loan, lien prevents you from selling the units and making capital gains.

To conclude, avail loans against MF investments in the bearish market than selling the units at a loss. You’d need to stay invested till the market stabilizes, avoiding any capital loss. However, in a bullish market, you better redeem your MF units to use capital gains for your short term financial needs than taking up a loan against them.

That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.

With this one can say “Mutual Fund Sahi hai”,  so let me do Nivesh