A financial crisis could strike at any time. Sometimes, the amount that you have earmarked for emergencies may not be sufficient. In such a situation, most individuals redeem investments originally earmarked for other financial goals. This could include mutual funds which they have been investing in for a period of time.
Is there a better option? Yes, a loan against your mutual fund investments.
How does a loan against a mutual fund investment work?
Just like you can get a loan against property and gold, you can also get a loan against your mutual fund investments.
The procedure is similar to how banks provide overdrafts. Any bank will offer you a loan against equity or hybrid mutual funds. To get the loan, you must pledge your mutual fund units as security. The bank will mark a lien against mutual fund units, which allows it to use the mutual fund units as collateral for a loan.
Banks will determine the amount of the loan based on the value of the units in the folio and the duration for which you want the loan.
As you repay the loan, the lien on the mutual fund unit progressively reduces.
What is a Lien?
When you sign a Lien, it means that the Bank is now deemed the owner of the mutual fund units and thus, has the right to sell or hold the fund.
The lender instructs a mutual fund registrar, such as CAMS or Karvy, to place a lien on the quantity of pledged units and lends you money against it. The registrar then stamps the lien and sends a letter to the lender, confirming the lien, with a copy to the borrower.
It is vital to note here that the lien is registered against the units, not the value of your investment. You will not be able to redeem the units until you have paid off the loan in full.
The bank can choose to enforce the lien in case the borrower defaults or is unable to pay off the loan. In such a case, the bank calls for redemption of the units and recovers the loan.
How can I apply for a loan against mutual funds?
If you have MF units in Demat form, you can quickly request a loan against your mutual fund investments. Otherwise, it would be best if you have a loan arrangement in place with the bank. To get a loan against your mutual fund investments, you will have to sign a Lien on it.
Advantages of taking a loan against mutual fund
Helpful in emergencies: You can pledge your mutual fund units online and get the money deposited into an account during emergencies or financial crises.
Short-term financial requirements: If you believe your mutual fund investment is sitting idle, this is a great option to raise funds for short-term financial needs swiftly. Without risking the ownership of your mutual fund units, you can borrow money from investment fund units for a brief period and repay it over time.
Affordable interest rate: A loan against a mutual fund is a secured loan. So, the interest rate on loans against mutual funds may be lower than the interest rate on unsecured loans like personal loans.
Stay invested: If you take a loan against your mutual fund units, you won't have to sell them. The pledged mutual fund units will remain invested and give returns. This keeps your financial plan intact and your fund ownership intact.
Pay interest on the used loan amount: You need to pay interest on the amount used, that is, the amount credited to your account, not on the total loan amount promised from the investment plan.
Things to keep in mind before taking loans against mutual funds
- You will only get a loan up to a certain amount, say 50% of your mutual fund value.
- The type of mutual fund scheme you have invested in and the financial institution you borrow from will affect the amount of loan you can get against your mutual fund assets.
- The financial institution may have restrictions on the minimum and the maximum amount you can borrow against your fund units.
- The loan against mutual funds facility may not be available in some banks and financial institutions.
- Banks might lend money only against a specific set of mutual fund plans.
Conclusion:
You might need to take loans for various purposes, even if you have money in your bank account. A loan against your mutual fund investments could help you tide over your short-term financial requirements, while allowing your investments to grow.