The need for financial assistance can arise at any time: medical emergencies, business and educational costs, home improvements, loan on mutual fund, and short-term cash flow needs. These situations prompt investors to consider redeeming their mutual fund investments. Redeeming the funds can affect your long-term financial planning objectives and may reduce potential returns.
What Is a Loan on a Mutual Fund?
A Loan on Mutual Fund (LAMF) is a loan secured in which you promise the mutual fund units you own to a bank or NBFC to receive funds. Your investment’s ownership is yours; it will be declared as pledged when you pay back the loan.
Why Choose a Loan Against Mutual Funds Instead of Redeeming?
The purpose of mutual funds is to create wealth over the long term. When you use them to meet the time of a financial crisis, and you don’t have the funds, you could be missing out on an increase in market value.
If you take a loan instead, your investments will remain on the market and could expand over time.
Avoid Exit Loads and Taxes
If you decide to redeem your mutual fund, you might be required to pay
- Exit load (if you redeem it before the lock-in time
- Tax on capital gains (short-term and long-term)
Lower Interest Rates Compared to Personal Loans
Because LAMF is a secured loan, lenders typically offer lower interest rates than unsecured personal loans.
Example:
- Personal loans typically carry higher interest rates.
- Loans against mutual funds typically have lower interest rates
- This is what makes LAMF an affordable borrowing choice.
Quick and Hassle-Free Process
Many banks and financial institutions are now offering digital processing for mutual fund loans. If the mutual funds you have are in demat format, it is usually simple and swift.
Large financial institutions like State Bank of India, HDFC Bank, and ICICI Bank offer loans to mutual funds, with a simple process and quick approval.
Loan-to-Value (LTV) Ratio
- The amount that you can borrow is dependent on the kind of mutual fund.
- Equity Mutual Funds: They typically range from 50% to 60% of the market value
- Debt Mutual Funds: Up to 70% -80% of the market value
Equity funds are more exposed to market risk. Therefore, they have a lower LTV than debt-based funds.
Interest and Repayment Options
Interest charged on LAMF is typically charged only for the amount used (if it’s designed as an account facility that is overdrawn).
Options for repayment comprise:
- Regular EMIs
- Repayment of an overdraft (pay the interest each month and the principal any time within the tenure)
- The bullet repayment is due at the close of the tenure
- A typical loan term is 6 to 36 months.
Who Should Consider a Loan Against Mutual Funds?
A loan secured by mutual funds can be a good option if:
- The urgent need for short-term cash is now.
- It is not a good idea to interfere with your long-term investment plan.
- You’re looking for lower interest rates than a personal loan.
- If you prefer a secured credit choice.
Final Thoughts
A loan to a mutual fund is a powerful financial management tool that lets investors increase cash loan without breaking investments—the benefits of long-term investing, with the simplicity of quick funding.
Instead of having to redeem the units of your mutual fund to disrupt your long-term wealth-building strategy, you could put them up for pledge and fulfil the financial demands of your immediate needs.
