In times of financial need, redeeming your mutual fund investments might seem like a quick solution. However, this action can disrupt your long-term financial goals and incur unnecessary costs. Instead, taking a loan against your mutual funds offers a more strategic alternative.
This method allows you to leverage your investments without liquidating them, preserving their growth potential and maintaining your financial plan. Here’s why taking a loan against mutual funds is a smarter choice.
Understanding Loans Against Mutual Funds
A loan against mutual funds is a secured loan where your mutual fund units serve as collateral. Financial institutions offer a percentage of the value of these units as a loan. The process is straightforward: you pledge your mutual fund units to the lender, who holds them until you repay the loan. During this period, you continue to earn returns on your investments, and once the loan is repaid, the pledged units are released back to you.
Benefits of Taking a Loan Against Mutual Funds
1. Preservation of Investment
When you redeem your mutual funds, you withdraw your investment, potentially during a market downturn. This could mean selling your units at a lower price and missing out on future gains when the market rebounds. By taking a loan instead, you maintain your investment position, allowing your funds to grow and benefit from market recoveries.
2. Lower Interest Rates
Secured loans typically have lower interest rates compared to unsecured loans like personal loans or credit cards. Since your mutual fund units act as collateral, lenders perceive less risk, resulting in more favorable interest rates for borrowers. This can significantly reduce your borrowing costs over the loan term.
3. Continued Returns
Even though your mutual fund units are pledged as collateral, they continue to earn returns. This means you benefit from the dual advantage of accessing funds while your investment grows. The returns from your mutual funds can potentially offset the interest costs of the loan, making it a financially efficient choice.
4. Flexibility in Usage
Loans against mutual funds offer flexibility in terms of usage. The funds obtained can be used for various purposes, such as meeting emergency expenses, funding a child’s education, financing a business venture, or even for investing in new opportunities. This flexibility makes it a versatile financial tool.
5. No Impact on Credit Score
Since the loan is secured by your mutual fund units, there is no immediate impact on your credit score when you take the loan. However, timely repayment of the loan can positively influence your credit history, reflecting responsible financial behavior.
How to Avail a Loan Against Mutual Funds
1. Check Eligibility
The first step is to check your eligibility with the financial institution. Most banks and non-banking financial companies (NBFCs) offer loans against mutual funds. Ensure that the mutual fund units you hold are eligible for pledging, as not all types may qualify.
2. Determine Loan Amount
The loan amount is determined based on the value of your mutual fund units and the lender’s loan-to-value (LTV) ratio. LTV ratios typically range between 50% to 80%, meaning if your mutual fund investment is worth ₹10 lakhs, you might be eligible for a loan of ₹5 to ₹8 lakhs.
3. Application Process
You can apply for the loan online or visit the lender’s branch. You’ll need to submit documents such as identity proof, address proof, and mutual fund statement. The lender will verify your details and process the loan. In many cases, the approval and disbursement process is swift, often within a few days.
4. Pledging Units
Upon approval, you’ll need to sign an agreement to pledge your mutual fund units. The lender will mark a lien on these units, meaning you cannot redeem or switch them until the loan is repaid. However, you can still continue to invest and earn dividends or growth.
Repayment Options
Loans against mutual funds come with flexible repayment options. You can choose to repay the loan in equated monthly installments (EMIs) or as a lump sum. Some lenders also offer the option to pay only the interest during the loan tenure and repay the principal amount at the end.
Potential Risks and Considerations
While taking a loan against mutual funds has several advantages, it’s essential to be aware of potential risks and considerations:
- Market Risk: The value of your mutual fund units can fluctuate with market conditions. If the market value of the pledged units falls significantly, the lender might ask for additional collateral or partial repayment to maintain the LTV ratio.
- Repayment Obligations: Ensure you have a clear repayment plan. Defaulting on the loan can lead to the liquidation of your mutual fund units by the lender, potentially at an unfavorable time.
- Interest Costs: While interest rates are generally lower, they still represent a cost. Compare the cost of taking a loan against redeeming your investments, especially if you’re considering it for a short-term need.
Conclusion
Taking a loan against mutual funds is a prudent financial strategy, offering liquidity without disrupting your investment plan. It allows you to meet immediate financial needs while preserving the potential for long-term wealth creation. By understanding the process and carefully considering the risks, you can make an informed decision that aligns with your financial goals.
In times of financial need, consider leveraging your mutual funds wisely through a loan, ensuring your investments continue to work for you while providing the funds you require.
