Life is unpredictable. As a result, you may encounter a brief cash crunch from time to time for a variety of reasons. It could be due to a home remodeling, a family wedding, or a medical emergency, for example. In such cash-strapped situations, the first thought is to utilize your savings and liquidate your investments, even if it means losing money. If that isn’t enough, you apply for a loan.
This, however, is not the greatest course of action. You can borrow against your mutual fund investments rather than sell them. Just as you can borrow against other assets such as gold and real estate, you can borrow against your mutual fund holdings from banks and non-banking financial institutions (NBFCs).
Attributes of Loans Against Mutual Funds
a) Limit of Your Fund
The amount of money you could borrow with your mutual fund holdings is determined largely by the sort of mutual fund scheme you have invested in and the financial institution from whom you will borrow.
Banks such as HDFC and ICICI, for example, lend up to 50% of the Net Asset Value (NAV) of equity mutual funds and up to 80% of the NAV of debt mutual funds. Axis Bank, on the other hand, offers up to 85 percent of the value of your debt mutual fund schemes and 60 percent of the value of your equity mutual fund schemes as a loan.
So, if your Fund is from TATA, the most important factor to be considered would be the Tata Mutual fund NAV.
b) Maximum Limit
Loans against mutual funds, like any other sort of loan, have particular restrictions. Several banks have a maximum and minimum loan amount that you can obtain.
For example, in the case of equity mutual funds, most large private banks, such as ICICI Bank – have set the minimum loan at Rs. 50,000 and the highest amount at Rs. 20 lahks, and in the case of debt mutual funds, the maximum amount is Rs. 1 crore.
The minimum and maximum limits are frequently greater in the case of NBFCs. Aditya Birla Finance, for example, has a minimum loan amount of Rs 25 lakh and a maximum credit amount of Rs 10 crore. The same can be said for Bajaj Finserv.
c) It is Not Available Everywhere
Several banks only lend money against a chosen group of mutual fund plans. For example, SBI exclusively makes loans against SBI Mutual Fund mutual plans. HDFC Bank and ICICI Bank are also picky about the projects for which they give money. Both of these private banks provide loans on mutual fund schemes handled by asset management firms registered with Computer Age Management. Similarly, Axis Bank has listed a number of mutual fund plans on its website as collateral for loans.
d) You Don’t Stop Earning Returns
When you pledge the mutual funds to secure loans, those unitsstay remain invested in the market. This is because the fact that when you pledge your mutual funds to a bank – you give the bank the right to sell off the mutual funds only if you default. Yet, as long as you do not default, your investments stay tied to the market and receive profits. As a result, you can maintain your financial plan while also raising much-needed funds on short notice without redeeming any units.
e) Cheaper Loans
A main benefit of a loan against mutual funds is that the interest rate is much lesser than that of credit cards or personal loans. This is because of the fact that loans against mutual funds are secured, meaning they are backed by collateral.
Loans against mutual funds, for example, will have an interest rate of 8-10%. This will vary depending on the bank and mutual fund programs you select. If you pledge units of debt funds – the interest rate is lower; if you pledge the units of equity fund schemes, the interest rate is greater.
Unsecured loans, such as credit card loans or personal loans, on the other hand, are not guaranteed by any financial assets that you hold. As a result, the bank is likely to charge a higher interest rate than 8-10% to compensate for the increased risk.
f) You Can Get It Online
Many banks, including SBI, HDFC, and ICICI, are now offering loans against mutual fund holdings online, thanks to advances in technology. All you have to do is pledge your mutual fund units online, and your account will be set up with an overdraft limit.
A credit agreement with your bank that permits you to withdraw more cash than you already have in your account is referred to as an overdraft facility. It has a predetermined limit. For example, if your bank account has 50,000 in it and your overdraft limit is Rs. 2 lakhs, you can take up to Rs. 2.5 lakh from it. The bank will charge you interest for using this overdraft option.
How to Apply for a Loan Against the Mutual Fund You Own?
If you have units in Demat form and have previous permission, many online portals will approve loans swiftly. If you physically hold the Fund, you need to have a loan arrangement in place with the financier/bank. The lender instructs a mutual fund registrar.
The registrar then marks the lien and sends a letter confirming the lien to the lender, with a copy to the borrower. It is critical to remember that the lien is registered against the units, not the sum. You cannot redeem the units until you have entirely paid off the debt.
Conclusion
Loans against mutual funds are a very rare activity due to a lack of knowledge and information on the subject. Hence, the next time you consider different strategies to raise a contingency fund, keep in mind that a loan against your mutual funds may be a better option than standard instruments.