Mutual funds usually not only give good returns in the long term, but they can also be your reliable companion in times of a financial crisis.
Mutual funds usually not only give good returns in the long term, but they can also be your reliable companion in times of a financial crisis. For, they can be used as security to avail loans from banks.
According to financial experts, loan against mutual funds, categorized under loans against securities, is an interesting, yet slightly overlooked financing option. Such a loan taken against either equity or debt-oriented mutual fund schemes could not just provide quick liquidity to the cash-strapped but is also slightly cheaper, i.e. between 11% and 13% p.a., than an unsecured loan like a personal loan (in the range of 11% and 16% p.a.) in most cases.
“A loan against mutual funds works as an overdraft facility after the borrower pledges his mutual fund units to the lender who attaches a lien on them and the borrower pays interest only on the actual loan amount used. Once you have repaid the loan, the lender will lift the lien and you will get the rightful ownership of your mutual fund units,” says Adhil Shetty, CEO, BankBazaar.com.
When it comes to the loan amount thresholds, lenders could offer up to 50% of the Net Asset Value of the pledged equity-based funds, and up to 80% of the NAV of the pledged debt funds and fixed maturity plans, subject to minimum and maximum loan amount limits.
While many banks and Non-Banking Financial Companies (NBFCs) offer loans against securities, a leading private sector bank launched a digital loan against mutual funds in 2018 which offered such loans in a completely paperless manner. Interested borrowers only need a savings bank account with that particular bank to begin the process. That said, currently only eligible folios with a single holding can be pledged for this particular loan facility.
Now, one of the advantages of taking a loan against mutual funds is that doing so prevents an investor from liquidating his investments at a loss during a cash-crunch. A digital loan could be quickly disbursed and the investor can continue his investments while also earning the dividends, if any.
However, not all mutual fund schemes are eligible for a loan. So, “aspiring borrowers must check with their lender in advance whether their mutual funds could be pledged for a loan or not with them. You also have the option of simply redeeming your mutual fund units while they are profitable, which reduces the need for you to borrow. Lastly, before finalizing your decision, ensure you’ve factored in other charges associated with the loan like the processing fee,” advises Shetty.