Loan Against Mutual Funds: A Smart Financial Move

Friday, December 06 2024
Source/Contribution by : NJ Publications

When it comes to life's significant moments like child education, marriage, retirement, etc., we probably have a plan in place. We even try to plan out our unplanned expenses by creating an emergency fund. But the fact is no matter how much planning we do, there will always be some unexpected expenses knocking at our door. Under such cash-strapped times, your first instinct might be to dip into your savings and sell off investments, even if it means taking a loss. Unfortunately, most of us prefer redeeming mutual fund units, considering the liquidity it offers.

Though this option might seem convenient in the short term, it may have a huge impact on the investors wealth creation journey in the long-run. So, is there any better option available? The answer is “yes”. Instead of liquidating your mutual fund investments, you can avail a loan against them. Similar to using gold or real estate as collateral, you can borrow money from banks or financial institutions using your mutual fund holdings and such facilities are called Loan Against Securities (LAS).

With LAS, one can continue his/her investment regardless of the circumstances he/she faces and continue to achieve his/her short term financial needs. Let us understand this with an example!

If one started an SIP of Rs. 10,000 monthly in Sensex TRI on 10th April 1999, his value after 25 years, i.e. as on 31st March 2024 would be Rs. 2,74,34,408 against the total investment of Rs. 30,00,000. However, during his investing journey if he had withdrawn Rs. 14,00,000 in total at different intervals for his unplanned expenses, the post-withdrawal value would be only Rs. 1,81,33,917 i.e. his overall wealth would have been reduced by almost 34%.

On the other hand, instead of withdrawing money for his unplanned expenses, if he had opted for LAS of the same amount @15%, he would have paid an interest of Rs. 5,98,353 in total. Even after paying this interest, he would be in a win-win situation because his SIP will continue to grow and his corpus would be more i.e. Rs. 2,68,36,055 (Rs. 2,74,34,408 - Rs. 5,98,353) even after adjusting the interest component.

Hence, one can earn more if he/she isn’t withdrawing rather choosing a loan against mutual funds. However, before opting for such loans one should consider a few important points which we will cover in this article.

How much loan can be taken?

Many banks set both a maximum and minimum limit on the amount of loan you can obtain. The limit of the loan depends upon the value and the volatility of the security that is pledged against the loan and this amount may differ from one bank/NBFCS to another as per their policy. For example, for equity or hybrid funds you can avail a loan of 45% to 50% of net asset value and in case of debt funds, the limit may exceed upto 65% to 80% of net asset value. However, not every mutual fund scheme can be pledged, one should check upon the list of eligible schemes with their respective banks or financial institutions in order to avail the loan.

At what interest rate?

Generally, the interest rate depends on the tenure of the loan and the institution from which it is taken. The interest rate on LAS is usually in the range of 11% to 16% per annum.

Any additional charges?

Generally, the processing fee is in the range of 0 to 1% of the loan amount or a fixed amount. Also, there can be additional document charges for the fresh loan and a top-up loan.

What will happen to the existing lump sum or SIP investments in mutual funds?

A loan against mutual funds does not impact your ownership rights over the mutual fund units, allowing you to capitalize on potential market appreciation and compound growth. The bank will only sell them if you fail to repay the loan as agreed.

Is it still really better than any other option?

Loan against mutual funds v/s redemption

An investor gets a choice between taking a loan against mutual funds or redeeming the mutual funds units. Early redemption of mutual funds units can lead to exit load. But in the case of loan against mutual funds, no such load would be charged to investors. Similarly, there are tax implications when equity or debt schemes are redeemed, while in case of LAS, no such question would arise for long-term or short-term capital gains. Moreover, your investment will continue to grow and you can benefit from the power of compounding in the long-term.

Loan against mutual funds v/s personal loans

Loan against mutual funds are backed by collateral which makes it less risky for lenders, hence, they charge less interest rates as compared to personal loans. The process of issuing such loans is comparatively quicker than that of other loans as the procedures are paperless in nature which can generate liquidity for investors when required. But, not every bank or financial institution provides a loan against mutual funds for every scheme like there are banks that provide loans only for a certain list of schemes selected by them.

Bottom Line

Any facility made available can be good as well as bad while financing it for oneself. With appealing interest rates, flexible repayment options and fast approvals, loan against mutual funds present an attractive choice for borrowers. However, it's crucial to consult financial advisors before making any financial decision, as achieving financial well-being depends on aligning your choices with your long term financial needs.