Loan Against Mutual Funds: Eligibility, Benefits, and How It Works

In today’s fast-paced world, liquidity needs can arise suddenly. While liquidating investments may seem like the easiest route, some alternatives allow you to meet your financial goals without disrupting your portfolio. One such option is called a loan against mutual funds.

It is an innovative financial product that provides a balance between keeping your investment and fulfilling urgent cash needs. In this blog, we will delve into the elements of this financial instrument, covering eligibility criteria, benefits, and how it works.

What Is a Loan Against Mutual Funds?

A loan against mutual funds is a secured loan option where your mutual fund investments are collateral. Banks and non-banking financial companies (NBFCs) provide loans against both equity and debt mutual funds. The loan amount is decided based on the value of your mutual fund units and the lender’s margin requirements.

Eligibility Criteria

Before applying for a loan against mutual funds, it is crucial to ensure you meet the eligibility criteria, which generally includes:

1. Type of Investor: Individual investors or entities holding mutual fund units can apply. These units must be in dematerialized form and registered with a recognized depository.
2. KYC Compliance: Borrowers must comply with Know Your Customer (KYC) requirements, including valid identification and proof of address.
3. Eligible Funds: Not all mutual funds qualify for this type of loan. Lenders typically prefer schemes from selected fund houses.
4. Age Limit: For individuals, the borrower must fall within the age range defined by the lender, usually between 18 and 65 years.

How It Works

1. Pledging Mutual Fund Units: The first step involves pledging your mutual fund units as collateral. These units remain in your name but are marked as pledged in the name of the lender.
2. Loan-to-Value (LTV) Ratio: Lenders decide the loan amount based on the LTV ratio, which usually varies between 50-75%, depending on the type of fund. Debt funds generally have a higher LTV ratio compared to equity funds due to their lower volatility.
3. Disbursal: Once the pledging is done, and all formalities are completed, the loan is disbursed, usually within a few hours.
4. Repayment: The loan can be repaid either through monthly Installments (EMIs). Once the repayment is complete, the pledge on the mutual fund units is released.

Benefits of Loan Against Mutual Funds

1. Preservation of Investments: Your mutual fund portfolio remains unchanged, letting it grow while you use the funds for your needs.
2. Lower Interest Rates: Since it is a secured loan, the interest rates are often lower compared to unsecured loans like personal loans.
3. Quick and Flexible: Loans are processed quickly through online mode. Borrowers also have the flexibility to choose the repayment date.
4. No Prepayment Penalty: Many lenders do not impose penalties for early repayment, offering greater flexibility in handling finances.
5. Tax Efficiency: The interest paid on the loan may be tax-deductible if the borrowed amount is used for investment purposes.

Scenarios Where This Loan Can Be Useful

1. Emergency Expenses: Medical emergencies or urgent financial needs can be addressed without liquidating your investments.
2. Business Expansion: Entrepreneurs can access funds to grow their businesses without depleting their savings.
3. Education Costs: Financing higher education or short-term courses becomes easier while retaining your financial assets.
4. Home Renovations: Undertaking home improvement projects without burdening your savings becomes possible.

Things to Keep in Mind

1. Interest Rate: Borrowers must compare interest rates across various lenders to ensure that they get the best deal.
2. Market Volatility: Equity mutual funds are subject to market risks, which can affect the value of your pledged units. Lenders may ask for additional collateral in case of an LTV breach.
3. Tenure: Choose a repayment tenure that aligns with your financial ability to avoid defaulting on any EMI.
4. Processing Fees: Check for hidden charges, including processing and documentation fees.
5. Redemption Restrictions: Since pledged units cannot be redeemed until the loan is repaid, ensure you won’t need immediate access to those funds.

Conclusion

A loan against mutual funds is the best option for people seeking quick funds without disrupting their investment portfolio. However, like any financial product, it needs careful evaluation of your financial situation and loan terms.

By understanding the eligibility criteria, benefits, and operational processes, borrowers can leverage this facility to achieve their financial goals efficiently.