In this age of digital surge and fintech, there is easy access to various types of loans, be it a personal loan, a home loan, a car, a loan against property or a loan against securities.
Among the loans against securities — which are essentially secured loans — one segment that seen a significant surge in the last couple of years, particularly after the COVID-19 pandemic, is ‘loan against mutual funds’ (LAMF).
With retail investor participation having increased in mutual funds (in the endeavour to generate wealth), so have LAMFs. Today, not just banks but also numerous fintech platforms with a lending function are offering loans against mutual funds.
Some fintech companies, such as 50Fin, Volt Money, and Smallcase, have integrated with CAMS and Kfintech, the mutual fund registrar & transfer agents (RTAs) for a seamless experience for investors/borrowers.
The RBI introduced the Account Aggregator (AA) Framework in 2021, enabling secure, consent-based financial data sharing between banks, lending institutions, and mutual funds, which has made offering loans against mutual funds easy. Banks and other lending institutions have integrated these loans into their apps and websites.
As a borrower, all you need is a smartphone, tablet or laptop with an internet connection, and you can have easy access to these loans sitting in the comfort of your home, office, café or wherever you are.
Data reveals that among the secured loan segment (wherein your valuable asset or investment is used as collateral by the bank or lending institution), the size of the loan against mutual funds is the fastest growing market after gold loans.
Also Read: SEBI Overhauls Mutual Fund Rules to Boost Transparency
The benefits
Loan against mutual funds has become popular among young borrowers, who need the money for whatever purpose, but do not wish to liquidate the investments and apply brakes on the power of compounding, particularly when the mutual fund scheme is performing well.
Moreover, there is a tax impact (short-term capital gains tax or long-term capital gain tax, as the case may be) when liquidating mutual funds, whereas there is no tax when availing of a loan.
Typically, you avail of 50-80% of the value of the investment as a loan (subject to a maximum of Rs 20 lakh in case of equity funds and Rs 1 crore for debt funds), pay a processing fee, and pay interest at the rate 10-12.5% p.a., depending on the bank or lending institution.
The interest rate on a loan against mutual funds is far lower than on a personal loan (which is an unsecured loan). Also, interest is charged only on the amount utilised from the loan, saving you, the borrower, from unnecessary interest payments on the unused portion.
Plus, unlike the other secured loans, you have the flexibility to repay – there are no equated monthly instalments (EMIs). You decided on your repayment amount.
Here’s the care you need to take when availing of a loan against mutual funds
- Consider it as a loan in need – Managing money, wealth, and debt is about prudence, temperament and discipline. Keep in mind you are bearing interest on the money borrowed.
Hence, consider a loan against mutual funds only when you are in serious need of funds. Analyse the financial requirement carefully and use the loan for productive purposes (for education fees or home loan downpayment) or debt consolidation (wherein you are repaying higher interest-bearing credit card debt) rather than for lifestyle needs.
- Avoid borrowing when markets are near the peak – Although doing so may facilitate you to avail of a higher amount as a loan, on the flip side, if the asset prices decline, you would face pressure.
You see, equities are a very high-risk asset class, and the market undergoes cycles. It isn’t necessary that the past returns would be repeated in the future.
Availing of a loan against mutual funds at the market peak or taking advantage of the current volatility in the equity market could prove costly in the current environment marked by geopolitical tensions, trade wars, and macroeconomic uncertainties.
Equity mutual funds, particularly the mid and small cap funds, may see greater drawdowns in case of corrections than the large cap funds. So, if you are taking a loan against mutual funds now and their market-linked value falls in the coming months, you may face a margin call, i.e., be asked to pay margin money or furnish more securities as collateral, thus weighing down on your wealth and health.
- Ideally, borrow when the markets are in a correction or bear phase – In such a scenario, instead of selling your mutual fund unit when you need money, availing of a loan may prove wise. Although you may not be able to avail a higher loan value, at least the risk here is calculated.
When the market begins to move up, you would not be subject to a margin call and find repaying the loan comfortable with the value of the investments appreciated.
- Do not lien funds that have earmarked for important goals (viz. your child’s future needs, your retirement, etc.) – These are important financial goals, which you plan for over the years. It is unwise to pledge mutual funds assigned for these goals. Be selective and practice restraint when you are considering a loan against mutual funds.
- Avoid being lax on repayments – Although you have the flexibility to repay the loan at your convenience, delaying repayments is not in the best interest of your financial well-being – it adds to your debt burden.
If, despite repeated repayment reminders from the lender, you don’t bother to repay, the lender may sell the valuable pledged mutual fund investment units to recover the outstanding loan amount.
Moreover, delayed or non-repayment of the loan would negatively impact your credit score. And then, when you are again in dire need of money, it may lower your loan eligibility chances.
Also Read: Rs 20 Lakh Lump Sum: Can Time Alone Do the Job?
To conclude…
Keep in mind that while a loan against mutual funds gives you access to money without having to liquidate/redeem your investments, it is a market-linked credit. Meaning the loan is subject to margin calls if the value of your investments erodes.
Hence, borrow sensibly, considering your financial requirements and use the money prudently for productive and strategic purposes. When a mutual fund is not performing, it is better to liquidate it rather than lien it for a loan.
A loan against mutual funds should ideally be considered for a financial emergency. Managing your hard-earned money prudently, and keep you debts in check in the interest of your financial well-being.
