Can you take a loan against mutual funds? Can you use your mutual funds as collateral? Keep reading.
Loans are usually not something you want to be taking every now and then, but they can be helpful, especially during a financial crunch.
Rather than impulsively selling your mutual funds (most likely, prematurely), you can take a loan against it in the event of a financial emergency.
Loans against mutual funds can help investors who happen to need money in a short period of time still preserve their investment and the interests they have taken so long to build.
In this article:
- How loans against mutual funds work
- Benefits of taking a loan against mutual funds
- Things to know about loans against mutual funds
- Who is eligible for loans against mutual funds
- How to apply for a loan against mutual funds
- Loan against mutual funds FAQs
Loan against mutual funds: How does it work?
The type of mutual fund schemes you have invested in and the financial institution from which you want to borrow will determine the amount of loan you receive.
When requesting a loan, the mutual fund units are used as security. Until the loan obligations are paid off, the bank retains custody of the mutual fund units as collateral.
Your mutual funds will still be invested, though. But the fund house will only release the lien to the financier (you) after the loan has been repaid.
Lien on mutual funds
Lien is the right the lender has over the mutual funds’ units to recover the debt provided the borrower did not repay the loan according to the agreed terms.
For example, when taking out a loan against a mutual fund, the lender places a lien on the mutual fund units that are being used as collateral.
Benefits of taking a loan against mutual funds
1. Lower interest rate
Interest rates are significantly lower because mutual funds are seen as secure.
2. You continue to earn returns
When you use your mutual funds to acquire a loan, the units still remain as investments. By collecting the loan, you are only pledging your units to the bank which gives them the right to sell the units in the event of a default. But your investment progress is not affected at all.
3. Full ownership of the funds
Just like the previous point, you still have full ownership of the funds. You are not required to redeem your mutual funds just because you want to take out a loan. You only forfeit this ownership when you default.
4. Fast liquidity
If you need money quickly, mutual funds can provide it. The banks see the worth and they can lend you a specific sum in exchange for your securities. Mutual funds serve as both an investment and a source of liquidity.
5. Easy repayment terms
You can get a loan against your valuable stocks and stock holdings with reasonable payback terms if you pledge them. Lenders give you free rein to make partial loan prepayments to keep repayment from being burdensome. Additionally, some may allow you a maximum of 36 or 48 months to pick from when choosing a tenor.
Things to know about loans against mutual funds
You can only get loans up to a specific percentage of your mutual fund holdings
The type of mutual fund scheme you invested in and the financial institution from which you will borrow determine how much money you can borrow against your mutual fund.
Certain banks would loan you up to 80% of debt mutual funds and up to 50% of equity mutual funds’ net asset value (NAV). For example, Stanbic IBTC Asset Management allows you to access up to 80% of your Investments as a loan.
It’s not a service available in all banks
Some banks only make this loan available for particular mutual fund plans. Loans on mutual funds administered by asset management firms may be available from some lenders.
Who is eligible for loans against mutual funds?
Anyone over the official legal age with money invested in mutual funds can apply for a loan.
However, the final disbursement always has certain terms and conditions and criteria the loan provider defines.
For example, for equity-oriented funds, most banks would only allow individuals to apply, but for debt funds, banks can consider a larger variety of people such as companies, sole proprietors, and also individuals.
How is the loan calculated?
The amount of loan depends mainly on two conditions:
- The type of mutual fund (Is it debt or equity funds?)
- The policies of the financial institution
How to apply for a loan against mutual funds
The process is the same as that used for overdraft services offered by financial institutions.
- Contact any bank or non-bank financial institution.
- Make your loan request and provide the mutual fund units as collateral.
- After submitting your application, they will review the quality of your assets before approving the loan.
However, be sure to review the lender’s list of mutual funds that are acceptable before applying.
Frequently asked questions
Can mutual funds be used as collateral?
Yes. Investors can leverage the value of their mutual funds and use them as collateral to borrow money from banks and non-banking financial institutions.
Can I get a loan on equity mutual funds?
Yes. You can obtain a loan on your equity mutual funds just as you can do with other assets like gold and real estate.
Is it good to take out loans against mutual funds?
It can be a smart idea to take out a loan against your equity funds if you have long-term stock investments. This way, you can satisfy short-term financial needs while maintaining enough wealth to achieve long-term objectives.
Will I continue to receive dividends if I take a loan against mutual funds?
Yes, you will still receive dividends on your investment. Taking a loan does not stop your return on investment.
Bottom line
Getting a loan against mutual funds is better than liquidating or selling your funds. Loans secured by mutual funds have lower interest rates and help you avoid taking on more expensive personal loans. However, you should only apply for short-term loans so that the loans can be repaid quickly over some months.
This creating more wealth