What is a Loan against Mutual Funds and How to Avail it?

Many individuals invest in mutual funds because they are a sound way to capitalise on the growth of the market and see a good rate of return. Mutual funds have been touted as the best way to counter inflation and witness long-term capital appreciation. When you have your money locked in sounds investments that you do not want to liquidate, how do you meet short term funding requirements that may arise? Taking out a loan against mutual funds may be the answer.

A loan against mutual funds is a loan in which units of mutual funds are kept as security or collateral. When you avail such a loan, you still hold the ownership rights to those units of mutual funds. However, you cannot sell or redeem the units until the complete repayment of the loan. Most banks and non-banking financial companies have a list of securities against which customers can borrow. Check these lists to see if you are eligible to borrow by keeping your mutual fund units as security.

Advantages of Loans Against Mutual Funds

Taking out a loan against mutual funds can be beneficial in several ways. You can use the proceeds of the loan to meet any short term personal or business requirements while at the same time holding on to your investments.

Since this kind of loan is backed by an asset or security, the interest rate on such a loan is lower. A personal loan or a credit card debt will charge higher rates of interest than a loan against mutual funds.

If you have made your investment under a SIP or Systematic Investment Plan, taking a loan backed by your mutual fund units will not hamper the plan. You can continue to make payments under your SIP while keeping your already owned units as security for a loan.

A loan against mutual fund units means that you need to make a lien on your units in favour of the bank. However, this does not mean that you don’t receive the dividends from your investment. You will retain the ownership rights to your units and continue to receive the dividends without any hassle.

How Does it Work?

The bank or non-banking financial institution will have a list of securities against which they offer loans. If your mutual fund units are eligible under this criterion, then you can apply for such a loan. Once the loan has been sanctioned, a lien will be created on the mutual fund units in favour of the bank. This means that while you retain ownership rights over the mutual fund units, the bank has the power to invoke the lien and sell your mutual fund units and keep the proceeds in case of failure to comply with the terms of the lien.

The amount which you can avail as a loan depends on the financial institutions. Most banks and non-banking financial institutions have a limit to how much you can borrow keeping mutual fund units as security. Generally, the limit is Rs. 20 lacs; however, this can go up to crores. The minimum amount which you must borrow is usually Rs. 1 lac.

How Much is the Interest Rate?

The interest rate on such loans usually ranges between 10% to 13%, which is lower than the interest rate charged for loans without any security such as personal loans. The interest rate will be applicable only on the amount of loan, which is utilised. If you withdraw money from your loan account for one day and pay it back on the next, then you will be charged interest on the amount withdrawn for only one day.

Conclusion

Loans against mutual funds are useful if you want to keep your investment intact while availing funds to meet your short-term requirements. You should ensure that you understand the terms of the loan before you make a commitment.