1. Loan against mutual funds
Among other considerations, you may consider borrowing against mutual fund units as a viable alternative. The advantage of doing so is that you don’t have to redeem your units prematurely. This also ensures that your (Systematic Investment Plan (SIP) remains unaffected.
The process is similar to the overdraft facility that bank accounts offer. You can avail loan against equity or hybrid mutual funds by approaching any non-banking financial company (NBFC) or bank. For the bank to consider your loan request, you need to pledge your mutual fund units as security for the debt. The loan will be given based on the value of units in the folio and the tenure you choose.
2. Interest rates for loans against funds
You can expect to repay the loan at an interest rate of 10-11% on the mutual fund units. Of course, this will be subject to terms and conditions set by the financier and loan tenure. Since it is a secured loan, the interest rate will be much lower than that of unsecured personal loans. Also, if your credit score is good or you have been a longstanding bank customer, the interest rate could be even less at the bank manager’s discretion.
3. Lien for mutual funds
Before we proceed further with the process to avail this loan, it is important to understand lien on mutual funds. Lien is a document that gives the bank the right to sell the fund or hold it. Hence, when you mark a lien in the name of the bank you grant the bank ownership of the fund units you own.
You need to approach your fund house and ask for a lien on your units in the name of the bank for a lien transfer to the bank. All the unit holders must sign the request letter for lien transfer, who jointly hold the mutual fund.
4. How to apply for loan against mutual funds
Many online portals 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/bank should be in place.
The lender asks mutual fund registrar like CAMS or Karvy 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. You cannot redeem the units before you completely repay the loan.
5. Availability of loan against mutual funds
It is important to note that the amount of money that you can get depends on the type of mutual fund you own. For instance, equity-based funds can fetch you close to 50% of the Net Asset Value of your funds. Some banks also have a maximum and minimum cap on the loan amount that that you can apply for.
6. How and when to remove the lien
Once the loan is repaid, the financier can send a request to the fund house to lift the lien. You can also enforce a partial removal of lien in case the financiers receive part payment. In such a situation, some units will be freed while the rest would still be under lien. The lien can be reinforced in case the borrower fails to repay the loan in the duration agreed upon.
Defaulting has consequences too. As mentioned earlier, in case the borrower fails to repay the loan according to terms and conditions agreed initially, the lender can reinforce the existing lien. In such a situation, the lender requests the mutual fund to redeem the units and send the cheque to the lender.
7. Benefits of borrowing against mutual fund units
- Loan against mutual funds is a good way to receive instant liquidity against the mutual funds unit you own.
- If you think your mutual fund investment is lying idle, this is a good way to increase potential return on your investment as well as quickly raise capital for short-term financial requirements.
- The interest rates for a loan against mutual funds can be lower as compared to personal loan interest rate although this is subject to the bank’s decision.
- If you opt for a loan against your mutual fund units you would not have to sell your units hence your financial plan and fund ownership remains intact.
Loans against mutual funds is quite a rare practice due to lack of awareness and information on the subject. So next time you think of alternate ways of raising a contingency fund, remember that a loan against your mutual funds can be a better option than traditional instruments.