Q. I am a 31-year-old IT professional, recently laid off from my well-paying jobs. Due to the current downturn in the IT space, I have not yet been successful in finding another job and currently, I am facing a liquidity crunch. Some of my acquaintances have advised me to avail a loan against my mutual funds units. Can you please elaborate on what is a loan against mutual fund units and how can one avail a loan against mutual fund units?
Loan against mutual funds units is a type of loan that allows investors to borrow money by pledging their mutual fund units as collateral. It is a convenient way to meet short-term liquidity needs without redeeming the mutual fund units and losing out on the potential returns.
To avail a loan against mutual funds units, one can either approach a bank or a non-banking financial company (NBFC) that offers this facility. The investor has to fill an application form and submit the required documents, such as identity proof, address proof, income proof, and mutual fund statement. The lender will then verify the details and value the mutual fund units based on the current net asset value (NAV).
The loan amount will depend on the type and category of mutual fund units, the lender's margin requirement, and the investor's credit profile. Typically, the loan amount ranges from 50% to 90% of the value of the mutual fund units.
For example, if an investor has invested Rs. 10 lakh in an equity mutual fund scheme and the current NAV of the scheme is Rs. 100 per unit, the value of the investment is Rs. 10 lakh. If the lender offers a loan against mutual fund units at 70% margin, the investor can get a loan of up to Rs. 7 lakh by pledging their mutual fund units as collateral.
Things to check
Before availing a loan against mutual funds units, one should check the following factors:
Interest rate: The interest rate for loan against mutual funds units varies from lender to lender and depends on the market conditions and the investor's credit score. It is usually higher than the interest rate for secured loans such as home loans or car loans, but lower than the interest rate for unsecured loans such as personal loans or credit cards. One should compare the interest rates offered by different lenders and choose the one that suits their budget and repayment capacity.
Tenure: The tenure for loan against mutual funds units is usually shorter than other types of loans, ranging from 6 months to 3 years. The investor has to repay the loan within the stipulated period, failing which the lender may sell the mutual fund units to recover the dues. One should opt for a tenure that matches their cash flow and repayment ability.
For example, if an investor gets a loan of Rs. 7 lakh at 12% interest rate for a tenure of 2 years, they will have to pay a monthly instalment of Rs. 33,032. If they choose a shorter tenure of 1 year, they will have to pay a higher monthly instalment of Rs. 62,333 but a lower total interest of Rs. 0.98 lakh.
Charges and fees: Apart from the interest rate, there may be other charges and fees involved in availing a loan against mutual funds units, such as processing fee, prepayment penalty, foreclosure charges, late payment fee, etc. One should read the loan agreement carefully and understand all the terms and conditions before signing it.
Impact on returns: Taking a loan against mutual funds units may affect the returns of the investment in the long run. The investor will have to pay interest on the loan, which will reduce their net returns from the mutual fund units. Moreover, if the NAV of the mutual fund units falls below a certain level, the lender may ask the investor to provide additional collateral or repay some part of the loan. This may force the investor to sell some of their mutual fund units at a loss or incur additional costs.
One should weigh the pros and cons of taking a loan against mutual funds units and assess their risk appetite and financial goals before making a decision.
For example, if an investor has invested Rs. 10 lakh in an equity mutual fund scheme that gives an annual return of 15%, they will have Rs. 14.49 lakh after two years (assuming no dividend or capital gain tax). If they take a loan of Rs. 7 lakh at 12% interest rate for two years and repay it in monthly instalments, they will have Rs. 11.56 lakh after two years (assuming no charges or fees).
This means their effective return from the mutual fund investment will be reduced from 15% to 7%. If during this period, the NAV of the mutual fund scheme falls by 20%, they will have only Rs. 9 lakh after two years (assuming no charges or fees). This means their effective return from the mutual fund investment will be negative (-5%). In this case, they may also face margin calls from the lender and have to provide more collateral or repay some part of the loan.
Kuvera is a free direct mutual fund investing platform.
Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.