Loan Against Mutual Fund

“Vision without execution is daydreaming.”
-Bill Gates

Financial crises can occur at any time. Loans are handy and are the first option most of them opt for. So today we would look into one the topic: -Which is the better option between loans against mutual fund and a personal loan? The answer is a loan against mutual funds because it allows you to borrow by putting your mutual fund investment as collateral with the bank. And since an asset class backs the loan, the interest rates are usually lower than the personal loan. You cannot redeem the mutual fund units as long as they are pledged with the bank but can redeem if you default.

Each bank offers a loan against mutual fund as per the list of approved mutual funds. It’s the agreement that banks own, on sale and hold your investments. The banks have all rights to sell your funds in case of default or non-payment of the loan amount.

How does it work?

Each financial institution will have a list of approved mutual funds against which they will be willing to give loans. You must enter into an agreement with the bank and grant ownership of the funds to the bank. It gives the banks the right to sell the fund in case of non-payment of personal loan. The limit of the loan amount is typically up to 50% of the Net Asset Value of the mutual fund units and in the case of equity and debt the loan limit is up to 70% to 80%.

So why loans against mutual funds are better than personal loans:

• Low-interest rates:

The loan against mutual funds is backed by collateral or security, and due to this reason, the interest rates are lower than the interest rate compared to a personal loan. Personal loans are given based on income and good credit score, while loan against mutual funds is given as per the percentage of NAV (Net Asset Value) of your funds. In a personal loan, the rate of interest is 13% to 36%, and the interest rate for a mutual fund is 10% to 12%. You can borrow an amount of Rs. 25000 and a maximum amount of 5 crores. You have to pay a processing fee from 0.25% to 1% of the loan amount.

• Investment benefit:

The primary benefit of loan against mutual funds is that your investment remains intact. Your SIP or further addition keeps adding to your mutual fund value. In case your NAV holding increases, you can ask the bank to re-adjust the interest rates or repay the partial loan amount. The personal loans are way easier to process, and this is the reason why most people run behind it. But it is always good to have a loan against security due to lower interest rates.

• Easy Access:

Mutual funds can help you to get capital in case of requirement. Mutual funds carry value, and banks give you a definite amount against your security. Besides, it’s a good idea to invest your funds in a mutual fund as it acts as an investment and can come handy as it has high liquidity.

However, Loans on mutual funds are quite a rare practice due to lack of awareness and information. Pledging mutual funds or securities should be the last option because mutual funds are subject to market risk. For example, if you have taken a loan of Rs. 1 lakh against a mutual fund corpus of Rs. 2 lakh and In case the market goes down and the value of your mutual fund dips to around Rs.1.6 lakh, the bank may ask you to put Rs. 20000 to make up the gap. So it is recommended that you check your finances and risk appetite before you opt for a loan against mutual funds