Mutual funds are a popular option for investors hoping to grow their wealth over time. But did you know that you could use your mutual fund investments as collateral for a loan? This article covers the principles of a loan against mutual funds, their benefits, and the crucial factors to take into account when selecting this financial product.
What is a loan against mutual funds?
A loan secured by mutual funds is similar to one secured by real estate. Financial assets in your portfolio, such as mutual funds, are mortgaged or pledged as loan collateral. Your loan application may be approved based on how much you borrow compared to the value and duration of the mutual fund units in your portfolio.
What is the Maximum Loan Amount that can be taken Against Mutual Funds?
The mutual fund plan will determine the maximum loan amount that we are eligible for. For debt mutual funds, ICICI Bank offers loans up to 80% of the NAV, and for equity mutual funds, up to 50% of the NAV. The State Bank of India offers loans with a 25,000 rupee minimum. For equity mutual funds, SBI offers a maximum loan amount of Rs. 20,00,000, and for debt mutual funds, it is Rs. 5,00,00,000. The minimum and maximum loan amounts are specified by the bank.
Features of Loan Against Mutual Funds
- Easy repayment: The parties to the loan and the borrower agree on the prepayment clause. Your loan account is immediately debited for the payment. Throughout the loan repayment period, your mutual fund holding is safe and secure.
- Process: It is not too difficult to apply for a loan against mutual funds, and the lending institutions provide all the information needed to process the application. Your mutual fund holding is only utilized as loan collateral; it does not affect the prepayment terms and conditions. Online loan applications against mutual funds are also available.
- Loan value: You may receive less funding if the proportion of equity funds in your portfolio is higher than that of debt funds. Generally speaking, you can borrow up to 50% of the equity and 80% of the debt. This is because banks require some assurance that they will be able to collect in the event of a default, and equity funds carry significantly higher risk than debt funds.
- Minimum and maximum loan value: The maximum amount you can borrow against your mutual fund holding is limited by certain banks. For instance, SBI mandates that the minimum loan amount you can apply for be Rs. 25,000 for your application to be approved for the use of mutual funds as collateral. The maximum loan amount for hybrid or equity funds is Rs. 20 lakh, and the maximum loan amount for debt funds is Rs. 5 cr. Additionally, these figures differ amongst banks.
- Secured ‘personal loan’: Personal loans typically have higher interest rates and are unsecured. However, the benefit is that the borrower receives the funds directly into their account and can use them as they see fit. Other secured loan types, like home or auto loans, are less expensive because the money is deposited directly into the seller’s account. A loan secured by mutual funds is comparable to a personal loan that is secured. Because the loan is collateralized and the money is deposited straight into the borrower’s bank account, the interest rate might be lower. The funds can be used however you please.
Benefits of loan against mutual funds
- Idle mutual funds can be put to use: For investors who have been investing passively in mutual funds, this is a great way to use the money wisely without sacrificing its holding value.
- Continue your SIP: You can keep building wealth even after you have pledged your financial securities. The ownership status of the lender remains unchanged. Thus, the borrowers can carry on with their mutual fund SIP. A loan secured by mutual funds is the best option to think about if you want instant secured funding at a lower interest rate.
- Interest rates: Consider personal loans and mutual funds as your best options for emergency credit. However, personal loans have higher interest rates than secured loans, such as those secured by mutual funds, which raises borrowing costs. As a result, while borrowers have the same unrestricted access to funds as with personal loans, mutual fund loans offer lower interest rates
- Instant liquidity: Generally speaking, the best way to get emergency money is through unsecured loans. On the other hand, unsecured loans typically have high interest rates. Furthermore, while applying for an unsecured loan, lending institutions place a greater value on a person’s CIBIL score. Because you are providing collateral as a safety net for the banks to grant you the loan, even someone with an average CIBIL score has a good chance of receiving the desired loan amount in the case of a secured loan. Therefore, one of the best options to think about is a loan against mutual funds if you want instant secured funding at a lower interest rate.
How does a Loan Against Mutual Funds work?
A loan against a mutual fund operates similarly to any other secured loan. For example, in the case of home loans, homeownership is held in trust by the bank and cannot be released until the loan is repaid within the agreed-upon time frame. Similar to this, in mutual fund-secured loans, the lending institution holds the borrower’s portfolio as security.
One benefit of unit pledging for mutual funds is that your investment is safe and keeps growing over time. When applying for a loan secured by mutual funds, you are not required to redeem any of your units. Until you are unable to repay the loan, the lender makes sure that your Systematic Investment Planning (SIP) in mutual funds or the entirety of your asset holding stays untouched.
At that point, a lien is placed, which is covered in more detail later in this article. Upon repayment of the loan, the securities are taken out of the pledge. Applying for a loan against mutual funds works similarly to applying for a bank overdraft (OD). But keep in mind that not all fund houses offer mutual fund investments to all banks. Before completing the collateral process, you might need to confirm this information with your lender.
Documents Required for Loan Application
- Identity proof: You can use your picture and entire name on identity cards such as your PAN card, driving license, Aadhaar card, and others.
- Address proof: Any document that has your name and permanent address on it, like an electricity or gas bill, ration card, or Aadhaar card, can be used.
- Income proof: If you receive a salary, you must submit your last three months’ worth of pay statements. If you work for yourself, you have to turn in your ITR file for the last three years along with an audited balance sheet.
What is the process to repay loans against equity and debt mutual funds?
The principal can be repaid after the loan term, but the borrower may choose to repay only the interest or both the principal and interest combined. The borrower might be offered the choice of making uneven payments or forced to make equal monthly installments. Via the loan dashboard of the financier, the repayment can be completed.
The lending institution will ask the mutual fund company or the registrar to take care of the lien removal and loan closure once we have paid back the loan balance. As long as the lender approves, as stated in the contract, a portion of the units may be released from the lien if a partial loan has been paid back. In this case, some units are released while the rest would be liens.
Conclusion
Without having to sell your investments, a loan against mutual funds provides a flexible and affordable way to get secured financing. This option offers immediate liquidity while protecting your portfolio, with advantages like reduced interest rates and ongoing SIP contributions. It’s a useful tool for investors with short-term financial needs.