Key Points about Borrowing Funds Using Mutual Funds
When faced with a cash-strapped situation, one option to consider is taking a loan against your mutual fund investments. This practice is gaining popularity in India, with several banks and Non-Banking Financial Companies (NBFCs) offering this service. Here's a guide to help you understand the key aspects of loans against mutual funds.
Eligible Mutual Fund Schemes
Loans are mostly provided against equity and debt mutual funds held in dematerialized or non-dematerialized form. However, lenders often have an approved list of mutual fund schemes eligible for pledging. Some lenders may restrict loans to mutual funds that have stable Net Asset Values (NAVs) or certain credit ratings, and not all funds qualify for loan collateral.
Maximum and Minimum Loan Amounts
Loan limits depend on the lender and type of mutual funds pledged. For example, IDFC FIRST Bank allows loans up to Rs. 10 lakhs for equity mutual funds and Rs. 50 lakhs for debt mutual funds per individual. Other lenders may have different ceilings. Minimum loan amounts vary by provider but typically must correspond with a minimum pledged value to cover credit risk.
Interest Rates
Interest is charged on the loan amount and usually depends on the lender’s policies and prevailing market rates. The rate may be floating or fixed, and interest is often charged only on the utilized portion of the loan. Lenders may revise interest rates subject to market changes.
Return on Pledged Units
When you pledge your mutual fund units, they remain invested in the market, and you continue to earn returns on them unless you default. However, you cannot redeem or sell the pledged units during the loan tenure. The units are lien-marked (locked) until the loan is repaid. Defaulting on repayment can lead to forced liquidation of the units by the lender.
Additional Conditions
The pledging arrangement typically does not allow you to use the loan to buy additional securities or invest further in mutual funds. The lender holds the collateral and can sell it without prior notice if the loan is in default.
Popular Providers
Several banks offer loans against mutual funds, including SBI, HDFC Bank, ICICI Bank, and Axis Bank. These banks lend against select mutual fund schemes. Axis Bank has listed a set of mutual fund schemes on its website against which it lends money.
Key Considerations
When taking a loan against mutual funds, ensure the scheme you want to pledge is accepted by the lender, know the maximum loan limit available on your fund type, understand the interest rate terms, and remember that while you retain earnings like dividends, you temporarily lose the ability to redeem or sell pledged units.
Loans against mutual funds typically have a lower interest rate compared to credit card loans or personal loans due to them being secured. The interest rate for loans against mutual funds can range from 8-10%. Loans can be applied online and result in an overdraft limit being set in the bank account. However, the minimum and maximum loan amounts at some providers like Bajaj Finserv are not specified in the article.
In summary, loans against mutual funds can be a useful financial tool in times of need. By understanding the key aspects and considering the eligibility of your mutual fund scheme, loan amounts, interest rates, and the status of returns on pledged units, you can make an informed decision about whether this option is suitable for your financial situation.
[1] Mutual Funds India [2] The Hindu BusinessLine [3] BankBazaar
A person might consider a fixed deposit as an alternative to a loan against mutual funds if seeking a more stable return on their investment, as fixed deposits have a fixed tenure and a guaranteed interest rate. Nevertheless, mutual funds could potentially offer higher returns in the long term.
In personal-finance management, it's essential to evaluate both loans against mutual funds and fixed deposits in the context of one's financial objectives, risk tolerance, and time horizon before making a decision.
