Unlocking Financial Flexibility With A Loan Against Mutual Funds

Mutual funds have long been favored as an effective investment option for individuals seeking to grow their wealth. However, what many investors may not be aware of is that these investment vehicles can also serve as collateral to secure loans. A loan against mutual funds can provide much-needed liquidity without selling your valuable assets, allowing you to meet immediate financial needs while benefiting from long-term investment growth. We are here to discuss the process of obtaining a loan against mutual funds, its benefits, and important considerations so that you can have a successful borrowing experience.

Understanding Loan Against Mutual Funds

A loan against mutual funds, also known as a loan against securities (LAS), is a form of secured loan where investors pledge their mutual fund units as collateral to obtain funds from a financial institution. The loan amount is typically a percentage of the total value of the mutual fund units pledged. The investor retains ownership of the mutual funds during the loan tenure and continues to earn returns and dividends on them.

Key Benefits of A Loan Against Mutual Funds

There are several reasons why taking a loan on your mutual fund investment plan is a great idea. Here are a few of them:

1. Retain Investment Benefits

One of the most significant advantages of taking a loan on mutual funds is that the investor retains ownership of the pledged units. This means that they can continue to benefit from potential market gains and income distributions.

2. Quick and Easy Access to Funds

Compared to traditional loans, the process of obtaining a loan against mutual funds is relatively quicker and less cumbersome. Since the loan is secured, financial institutions are generally more willing to extend credit without stringent eligibility criteria.

3. No Need to Liquidate Investments

By availing a loan against mutual funds, investors can avoid the need to sell their mutual fund units during a market downturn, which may lead to potential losses.

4. Competitive Interest Rates

The loan against mutual fund interest rates are typically lower than those on unsecured loans, making it an attractive option for borrowers.

Steps to Obtain a Loan Against Mutual Funds

Step 1- Choose the Right Financial Institution

Start by researching and comparing different financial institutions that offer loans against mutual funds. Look for reputed institutions that offer favorable terms, competitive interest rates, and flexible loan tenures.

Step 2- Check Eligibility Criteria

Each financial institution will have specific eligibility criteria for availing the loan. Generally, the mutual funds must be held in dematerialized form, and certain fund categories may not be eligible. Verify your eligibility before proceeding.

Step 3- Calculate Loan Eligibility

The loan amount you can get against your mutual funds depends on factors such as the type of mutual fund, its Net Asset Value (NAV), loan-to-value (LTV) ratio set by the lender, and the risk profile of the mutual fund.

Step 4- Apply for the Loan

Once you have identified the lender and determined your eligibility and loan amount, submit the application along with the required documents. The documents typically include KYC details, mutual fund statements, loan application form, and an agreement to pledge the mutual fund units as collateral.

Step 5- Complete Formalities

After the application is processed, the lender may conduct due diligence on the pledged mutual funds. Once the formalities are complete, the loan amount will be disbursed to your designated bank account.

Important Considerations

  • Risks Involved: While a loan against mutual funds offers numerous benefits, it’s essential to understand the risks involved. If the value of the pledged mutual funds declines significantly, the lender may require additional collateral or partial repayment of the loan.
  • Impact on Investment Strategy: Consider how taking a loan against your mutual funds aligns with your long-term investment strategy. Assess whether the borrowed funds will be utilized for productive purposes and whether the potential benefits outweigh the costs.
  • Loan Repayment: Timely repayment is crucial to avoid any negative impact on your credit score and to ensure the smooth continuation of your investment plan.

Loan Against Mutual Funds: Interest Rates and Determinants

The interest rate on a loan against mutual funds can vary depending on several factors, and it’s typically lower than the interest rates on unsecured loans due to the collateral provided by the mutual funds. The specific interest rate charged by the lender will be mentioned in the loan agreement. Here are some determinants that can influence the interest rate on a loan against mutual funds:

1. Lender’s Policy

Different financial institutions may have varying policies regarding the interest rates they offer on loans against mutual funds. Some lenders might offer more competitive rates to attract borrowers, while others may have fixed interest rates for all borrowers.

2. Loan Amount

The loan amount sanctioned against your mutual fund units can affect the interest rate. Typically, larger loan amounts may be eligible for lower interest rates, as they provide more substantial collateral for the lender.

3. Loan Tenure

The loan tenure, that is, the duration for which the loan is taken, can also influence the interest rate. Shorter loan tenures might have slightly lower interest rates compared to longer-term loans.

4. Loan-to-Value (LTV) Ratio

The loan-to-value ratio is the percentage of the mutual fund’s net asset value that the lender is willing to lend. A lower LTV ratio may result in a lower interest rate, as the lender has a higher margin of security in case the value of the mutual fund units fluctuates.

5. Creditworthiness

While a loan against mutual funds is a secured loan, some lenders may consider the borrower’s credit history and creditworthiness when determining the interest rate. A borrower with a strong credit score may be offered more favorable interest rates.

6. Type of Mutual Fund

The type and category of mutual funds being offered as collateral can also play a role in determining the interest rate. Generally, well-established and stable mutual funds may result in more favorable interest rates.

7. Market Conditions

The prevailing market conditions and interest rate environment can influence the interest rate offered by lenders on all types of loans, including loans against mutual funds.

Conclusion

Unlocking financial flexibility through a loan against mutual funds can be a prudent financial decision for investors seeking liquidity without sacrificing their long-term investment goals. By pledging mutual fund units as collateral, investors can access funds quickly and conveniently, all while retaining ownership and potential growth of their investments.

Amit Arora Finnable

AMIT ARORA

I am a seasoned retail banker with over 21 years of global experience across business, risk and digital. In my last assignment as Global Head Digital Capabilities, I drove the largest change initiative in the bank to deliver the end-to-end digital program with over US$1 billion in planned investment. Prior to that, as COO for Group Retail Products & Digital, I implemented a risk management framework for retail banking across the group.
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