Life often presents unexpected financial challenges, prompting the need for immediate solutions like tapping into savings or selling investments. However, there’s a more strategic approach: obtaining a loan against mutual funds. Similar to using assets like gold or real estate as collateral, mutual fund holdings can secure loans from banks or non-banking financial companies (NBFCs). Here are some crucial considerations when contemplating such a loan.
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Loan Availability and Amount Linked to Mutual Fund Holdings
- The loan amount one can access against the mutual funds hinges on the specific type of mutual fund one possesses. For instance, equity-oriented funds may allow one to secure approximately 50% of the fund’s net asset value (NAV) as a loan.
- Many banks impose upper and lower limits on the loan amount one can apply for, regardless of the NAV of one’s mutual fund holdings.
- The loan amount one can obtain also varies based on the particular mutual fund scheme one intends to use as collateral. Typically, one can access around 50% of the value of the pledged equity or hybrid mutual fund schemes.
- This loan amount is determined by multiplying the NAV of the units by the number of units one holds, but it is subject to a maximum limit set by the lending institution.
- For example, if the equity fund holdings are valued at ₹10 lakhs, one might be eligible for a loan of approximately ₹5 lakhs using these holdings as collateral.
- Loan amounts for debt mutual funds may be higher, ranging from 80–85% of the value of the pledged funds. Different lending institutions have varying margin requirements for loans secured against equity and debt mutual funds.
Borrowing Limits Against Mutual Funds
- Loan limits against mutual funds are subject to specific constraints, including both upper and lower limits.
- Many banks set the minimum loan threshold at ₹50,000 and cap the maximum amount at ₹20 lakh for equity mutual funds.
- For debt mutual funds, the maximum loan amount can extend up to ₹ 1 crore.
- NBFCs often have higher minimum and maximum thresholds for loan amounts compared to banks.
Lien on Mutual Funds Explained
A lien is a legal document that grants the bank the authority to either sell or retain the fund. In essence, if one establishes a lien in favour of the bank, one essentially transfers ownership of one’s fund units to the bank.
To initiate this, one must approach the respective fund house and arrange for a lien on the units, with the bank named as the beneficiary. This necessitates the signature of all unit holders on the lien transfer request.
Lien Removal Procedure
- Upon successful repayment, the lender may request the fund house to lift the lien or opt for partial lien removal if partial payments were made.
- Defaulting on loan repayment allows the bank to reinstate the lien and petition the mutual fund to liquidate the units.
- Proceeds from the liquidation are then remitted to the lender via cheque.
Online Loan Application Process
- With advancements in technology, many banks and NBFCs now offer online platforms for applying for loans against mutual fund holdings.
- Through these platforms, one can pledge mutual fund units online, establishing an overdraft limit in the bank account.
- Leading financial institutions like Share India provide web and app-based platforms for easy loan applications.
- The overdraft feature allows withdrawals beyond one’s account balance, up to a predetermined limit, subject to interest charges by the bank.
- Online portals expedite the loan approval process, especially for Demat account holders with prior authorization.
- For physical possession of fund units, a loan agreement with the lender is necessary, along with placing a lien on the units through a mutual fund registrar.
- The lien is tied to the units and restricts redemption until the loan is fully repaid.
Pledged Mutual Fund Units Still Bring Returns
- One’s mutual fund units, used as collateral for a loan, remain invested in the market.
- Only in the event of loan default can the bank liquidate these units.
- As long as loan obligations are met, one’s investments continue to earn returns.
- This strategy allows for acquiring funds without redeeming any units, preserving the financial plan.
Conclusion
Securing loans through mutual funds involves utilizing the pledged funds as collateral to acquire the loan. A few advantages comprise making interest-only payments, flexible repayments, and shorter loan durations. The loan size or interest rate could vary based on the mutual fund type or the particular mutual fund company. A loan against mutual funds is better when weighed against credit cards or personal loans. The loan against mutual funds interest rate is notably lower than those for loans backed by gold or fixed deposits (FDs). So, before investing in mutual funds, always verify if they can be pledged to secure a loan.
