Mutual funds are multi-benefit investment avenues. Apart from the fact that they are highly liquid – meaning, they can be quickly converted to cash, mutual funds in your portfolio can also serve as collateral for loans, that is, you can get a loan against mutual funds. This comes in handy for investors who require money in the short term but are not keen to liquidate their investments just yet. In this article, we will understand how you can get a loan against your mutual fund holdings.
This article covers:
What is a loan against mutual funds?
A loan against mutual funds is similar to a loan against property. In this case, financial securities in your portfolio, such as your mutual fund holding, are used as mortgages or are pledged as security for the debt. Your loan application may be accepted on the basis of how your borrowing amount compares with the value of the mutual fund units in your portfolio and their tenure.
The process of applying for a loan against mutual funds is similar to that of taking an Overdraft (OD) from a bank. However, remember that not all banks accept mutual fund investments from all fund houses. You may need to verify this information with your lender before you finalise your collateral.
With pledging mutual fund units, the advantage you have is that your investment remains safe and continues to compound over time. You do not have to redeem any of your mutual fund units when seeking a loan against mutual funds. The lender ensures that your Systematic Investment Planning (SIP) in mutual funds continues or your total asset holding remains untouched until such time you are unable to pay back the loan – there is a lien placed – something that is discussed a little later in this article.
Features of loan against mutual funds
A loan against mutual funds might be a very convenient option in case of emergency funding. Here are some more features that you need to know when taking a loan against mutual funds:
In case, your portfolio allocation has more equity funds than debt funds, then there is a possibility that you get lesser funding. In general, you can get a loan of up to 50% of equity funds and 80% of debt funds. This is because the risk involved in equity funds is far higher than that in debt funds, and banks need some surety of them being able to collect in case of a default.
Minimum and maximum loan value
Some banks have a limit on the amount you can borrow against your mutual fund holding. SBI, for example, requires the minimum loan value you can apply for to be Rs 25,000 for your application to be eligible to accept mutual funds as collateral. Maximum loan value in the case of equity or hybrid funds is capped at Rs 20 lakh and borrowing against debt funds is capped at Rs 5 cr. These values also vary from bank to bank.
Secured ‘personal loan’
Personal loans are generally unsecured and come at a higher rate. But the advantage is that the money comes directly into the borrower’s account and the borrower is free to use it without limitations. In other kinds of loans that are secured and therefore cheaper, such as home loans or auto loans, the amount goes to the seller’s account directly. In the case of a loan against mutual funds, it can be equated to a secured personal loan. The interest rate may be lesser because it is secured through collateral, and the loan amount is credited directly into the bank account of the borrower. There are no limitations on the usage of the funds.
The prepayment clause is mutually agreed upon between the lending and the borrowing party. The payment is debited directly from your loan account. Your mutual fund holding remains safe and secure throughout the loan repayment period.
Applying for a loan against mutual funds is relatively easy and the lending institutions communicate all the details regarding the application at the time of processing. Your mutual fund holding is purely used as collateral for the loan and will have no bearing on the terms and conditions of prepayment.
How does a loan against mutual funds work?
The working of a loan against a mutual fund is similar to that of any other secured loan. For instance, in the case of home loans, the homeownership rests with the bank as collateral until the loan is repaid within the predetermined time period. Similarly, in the case of loans against mutual funds, the portfolio holdings of the borrower are held as security by the lending institution.
Till then your mutual fund holdings remain pledged with the financial institution. You cannot redeem the units or liquidate your portfolio holding in the market. However, you may continue with your SIP investments. The securities are held with the lender till the time of repayment. Once the loan amount is repaid, the securities are released from the pledge.
Benefits of loan against mutual funds
Majorly unsecured loans are the best way to secure emergency funding, however, the interest rates of unsecured loans are usually high. Moreover, the lending institutions give higher weightage to CIBIL score when one applies for an unsecured loan. In the case of a secured loan, even an individual with an average CIBIL score has a high chance of getting the desired loan amount because you are submitting collateral as a failsafe for the banks to give you the loan. Therefore, to get instant secured funding, with a lower interest rate, a loan against mutual funds is one of the best options to consider.
Idle mutual funds can be put to use
It is a great solution for those investors who have been passively investing in mutual funds to put the amount to good use without disturbing the holding value.
You can compare loans against mutual funds to personal loans, as both of them are the best suited for emergency credit. However, the cost of borrowing increases in the case of personal loans as the interest rates are higher when compared to a secured loan such as a loan against mutual funds. Hence, borrowers can enjoy cheaper interest rates on loans against mutual funds than on personal loans, even as they enjoy the unrestricted use of the money like with personal loans.
Continue your SIP
Even after pledging your financial securities, you can continue the process of your wealth creation. The lender’s ownership status does not change, therefore the borrowers can continue with the SIP in the mutual funds.
How to lift the Lien?
A lien refers to a claim or legal right against assets that are typically used as collateral to satisfy a debt. When a loan against a mutual fund is given, the bank cannot claim the mutual fund holdings even though it is being used as collateral. The ownership of the fund remains with the borrower. What happens is a lien is placed on the funds by the Asset Management Company (AMC) to whom the mutual fund scheme belongs. In case of a default, the bank may ask the AMC to enforce the lien to sell the units, and the money goes to the bank against the loan taken. An important point to note is that the lien is marked on units and not on the amount. Also, no units can be redeemed unless the loan is repaid.
Once the loan is paid back, the lien is lifted. The borrower has to provide in writing that the amount has been paid back, and then the lender informs the mutual fund house or the Asset Management Company (AMC) to lift the lien from the pledged securities.
Once the lien is lifted, the securities are released from the AMC’s end. Partial release of funds is also possible if the lender approves of the same. If the half payment of the borrowed fund is done, borrowers can approach the lender for the NOC letter, and then the part of the securities is revoked from the lien.
The process to apply for a loan against mutual funds
There are two ways in which you can apply for a loan against mutual funds.
- An offline method by visiting the lenders’ branch
- An online method where you visit the lender’s website
These are the steps to be followed for the loan application procedure:
In the case of loans against mutual funds, the overdraft facility is provided by the lender to the borrower. Therefore, an overdraft account is opened by the lender in the name of the borrower. The limit on the OD account is set as per the value of the mutual fund.
Next, all the details regarding the mutual fund are given to the lender by the borrower. Details such as scheme name, mutual fund house, number of units, and others are provided to the lender.
Following this, the lender gives all the details to the mutual fund registrar. The registrar then provides a contract with the marking of the lien. The contract includes the number of units being pledged by the borrower.
Lastly, the contract has to be signed by the borrower, confirming the lien to the lender.
To revoke the lien you need to repay the borrowed funds and take NOC from the lender. Post this the mutual fund house will release the pledged units of the mutual funds.
Documents required for loan application
The list of documents is similar to that of all other secured loans. The list includes:
- Identity proof: Aadhaar card, PAN card, driving license, and other identity cards with your photograph and full name can be used.
- Address proof: You can use any documents where your name and permanent address are mentioned, such as an Aadhaar card, ration card, electricity bill, and gas bill.
- Income proof: If you are salaried, you need to submit your salary statements for the past three months. In case you are self-employed, you need to submit the past three year’s ITR file with an audited balance sheet.
Loans against mutual funds are not very popular in India, mainly because of the lack of awareness of such a facility. Loans against mutual funds provide easy access to funds at a potentially lower rate than a personal loan while providing the borrower with the flexibility of a personal loan. Investors in mutual funds may consider this option should they need funds in the short term but do not want to sell their investments.