What does one do in case there is an immediate requirement of cash to renovate the house or to pay for a holiday while most of your funds are already locked in mutual fund units?
One of the convenient ways to address the problem is to redeem the mutual fund units while the other alternative is to raise a bank loan against a lien on them.
Wealth advisors argue that instead of redeeming existing mutual funds, one can take a loan against these mutual funds so that long term financial goals are not disrupted. Also, as one redeems the securities prematurely, one has to forgo the potential future returns arising out of these investments.
“Let’s say that mid cap or small cap funds offer a return of 15 to 18 percent over a period of 3 to 5 years. If you are paying only 10 percent interest on loan, then you can still make 5 to 8 percent alpha. On the contrary, if you sell the units instead of raising a loan, you lose out on opportunity to earn the gains,” says Sridharan Sundaram, a SEBI-registered investment advisor and Founder of Wealth Ladder Direct.
Preeti Zende, a SEBI-registered investment advisor and co-founder of Apna Dhan Financial Services echoes similar sentiments.
“Mutual funds can be helpful whenever you need money. Instead of redeeming your existing mutual funds which are mapped to long-term financial goals, you can take a loan against these mutual funds. The interest rate on these loans is lower than that of personal loans. So, it is a good option,” she said.
“A number of online platforms offer instant loan facility. Loan against mutual funds is also offered there but it is better to take a loan from a good public or private bank or NBFC. So, it is better to deal with known sources only, instead of relying on apps giving easy credit,” she added.
How does it work?
The loan against mutual funds (LAMF) is usually offered as an overdraft facility where one has to give the fund units as collateral to financial institution and in return, one stands to get an overdraft facility. The overdraft limit is usually 50-60 percent of the market value of equity funds and 80-85 percent of debt funds.
Based on the requirement, one can use the funds within the limit of overdraft facility – and interest is levied on the utilised amount only.
The rate of interest varies from institution to institution and usually revolves around 9-10 percent per annum.
Array of options
There are a number of options available to seek loan against mutual funds. One such option is to raise from any mainstream financial institution such as a large commercial bank – SBI, Bank of Baroda or HDFC Bank while there are several NBFCs (non-banking financial company) and digital platforms which offer such loan.
These include Tata Capital, Dhanlap and Mirae Asset Financial Services.
Benefits of raising loan
One of the key benefits of raising loan against mutual fund (LAMF) is that borrower does not need to redeem his/her securities, which are likely to offer far higher returns in the long run as compared to rate of interest charged on the loan against mutual fund units.
Also, raising loans against securities is convenient as one does not need to show any income proof, salary slip or form 16. “It is better to pay 10 percent interest on loan instead of letting go of 16 to 18 percent return that one can possibly earn on the fund units. Overall, it makes sense when it comes to equity funds, but in case of debt funds, the scenario changes and therefore, it may not be as financial wise as it is in case of equity funds,” adds Sridharan.