How to avail loan against mutual funds

 

Imagine a situation you need money urgently but you can not raise the fund easily by selling your assets easily. It could be due to various situations like you have invested in real estate or Gold or any other asset class which can not be liquidated easily.

But if you have invested in mutual funds, you can obtain loan against mutual fund units without liquidating them. Banks will be ready to give you loan on mutual fund units but you will have to assess the cost involved and merit/demerit of this approach.

How loan against mutual fund units work?

Many banks and NBFC's accept mutual fund units as collateral for loan or overdraft facility.

Tenure for overdraft facility will be usually one year and after that it has to be renewed by paying renewal charges. Tenure will be flexible like 3 months, 6 months or 1 year. Usually there will be no foreclosure charges.

Loan process works by pledging the MF units using lien marking. It could be done digitally as well through OTP based verification. Borrower can select the mutual fund scheme and number of units. If it's offline mode, borrower will fill the form with necessary details and it is forwarded to mutual fund registrar for lien marking.

MF NAV fluctuates lien marking might also go through changes. Borrower can sell other units in case of partial units pledging. If NAV goes significantly, marking also can also be updated.

Once lien marking is done, you can not sell the units pledged. But can continue to receive extra units in case of growth mutual funds.

An account typically overdraft facility will be opened. You will be charged interest for the amount used.

Margin on funds

Borrower will not get 100% value of mutual fund unit as loan. It will be some percentage of the market value of units. This is called haircut or margin. Usually loan amount will be 50%- 60% of NAV  for equity funds and 75% - 80% of NAV in for debt mutual funds.

What happens if you fail to pay back the loan?

In case borrower fails to repay the loan, the bank can invoke the lien and can seek redemption of units under lien, to recover the loan.

Can you use all types of mutual funds?

Banks/NBFC's will have list of mutual funds approved for this facility. 

Redeem or Borrow?

To arrive at the decision, you have to take into consideration many aspects like

1.Is it a short requirement or long requirement? How long will it take to repay the loan? If it's a short term requirement like 3-12 months, you can opt for loan against mutual funds. Rationale behind is that you might earn more from the mutual fund gains than the amount you pay back to bank for loans. 

2.Expected return for the period versus the cost of borrowing

If your return on investment is not much compared to interest you pay for the loan and other charges involve, then better go with redeem. It is especially true with respect to debt funds. 

3.Market Trend

If you are seeing a bull market, then exiting mutual funds is not right approach.

4.Exit load and tax impact

Exiting mutual funds may incur exit load as well short term/long term capital gain tax. If you remain invested, you will be saved from this and investment will also grow.

If you have invested in debt mutual funds before 1 April,2023; there is a indexation benefit to save on tax. So redeeming might go against indexation benefit.