On your personal finance journey, no matter how good you are at planning, sometimes things go wrong. An emergency or unexpected expense can deplete your emergency fund. And next, you might be pushed to sell your investment assets or take a risky loan.
Since selling your mutual funds might not be ideal, one option gaining traction is taking a Loan Against Mutual Funds (LAMF).
Let’s dive in and unpack what LAMF means and whether it’s the right move for you.
Estimated read time: 4 minutes and 25 seconds
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Buckle up. Here we go!
What is a Loan Against Mutual Funds?
As the name suggests, a loan against mutual funds is a loan offered by financial institutions with your mutual fund holdings as collateral. Think of LAMF like a loan against your gold jewellery. Instead of gold, you pledge your mutual fund units.
In India, LAMF is slowly gaining popularity. More banks, NBFCs, and FinTechs have started offering loans against equity and debt mutual funds. These loans are typically short-term, with durations under 12 months.
When you pledge your mutual fund units as security to the lender, they extend a loan to you based on the value of those units. The loan amount usually ranges from 50% to 80% of the mutual fund’s value.
So, if you have mutual fund units worth ₹1 lakh, you might be eligible for a loan of ₹50,000 to ₹80,000, depending on the lender’s policies.
How does a loan against mutual funds work?
Here’s the basic process:
- Eligibility Check: Not all mutual funds are LAMF-friendly. Your lender will check if your chosen funds are on their approved list. For example, SBI only accepts a few selected SBI mutual funds as collateral.
- Loan Amount: The lender will determine the maximum loan amount based on a percentage of your mutual fund’s value. This percentage varies depending on the fund type (debt or equity) and the lender’s policy. For example, a lender might offer a loan of up to 50% for equity funds and 80% for debt funds. NBFCs offer high loans compared to banks.
- Margin Requirement: This is the difference between the loan amount and the value of your pledged units. Basically, it’s a safety net for the lender. You might need to add more units (collateral call) to maintain the loan-to-value ratio if the value of your mutual funds falls significantly.
- Interest Rates: LAMF interest rates are generally lower than personal and credit card loan rates. Most banks and NBFCs charge an interest rate between 9 to 12%.
Remember, the lender has the right to sell off your mutual fund units to recover the outstanding amount if you fail to repay the loan and the interest as per the agreed terms.
Should you take a loan against your mutual funds?
Now, the big question: Is it a good idea to take a loan against your mutual funds? Well, there’s no one-size-fits-all answer. It depends on your financial situation and needs.
Here’s a breakdown of the pros and cons to help you decide:
Benefits of loan against mutual funds:
- Quick Access to Cash: One of the significant advantages is the speed at which you can access funds. Unlike applying for a new loan, which can take time for approval and disbursal, a loan against mutual funds is relatively quick.
- No CIBIL Score Required: For LAMF, many banks and NBFCs don’t have any minimum credit score requirements. Therefore, you can access this loan with low-interest rates even with a low credit score.
- Overdraft Facility: Many banks and NBFCs provide an overdraft facility against your mutual funds like they offer FDs. By this, you only have to pay the interest for the amount you use.
- Lower Interest Rates: As mentioned earlier, these loans’ interest rates are typically lower than personal and credit card loans because they’re secured against your mutual fund units. So, if you’re in urgent need of funds, this could be a cheaper option.
- No Need to Liquidate Investments: Instead of selling your mutual fund units and potentially missing out on future market gains, you’re leveraging them to access liquidity. This means you can continue to benefit from any appreciation in the value of your investments.
- No Capital Gains: Through LAMF, you can cover your requirements without selling your mutual funds. If you had sold your mutual funds, you would have to pay the capital gains taxes.
Disadvantages of loan against mutual funds:
- Risk of Losing Assets: While your mutual fund units serve as collateral, there’s still a risk involved. The lender can sell off your units to recover the outstanding amount if you’re unable to repay the loan as per the agreed terms. This could potentially erode your investment corpus and disrupt your long-term financial goals.
- Collateral Call: If the market falls, your pledged units could lose value. This might trigger a collateral call, forcing you to add more units or risk having your units sold to repay the loan.
- Interest Costs: While the interest rates on loans against mutual funds may be lower than personal and credit card loans, they’re still costs you have to bear. If you’re unable to manage the interest payments along with your other financial commitments, it could strain your finances further.
- Potential Loss of Investment Returns: The interest you pay on the loan eats into your potential mutual fund returns.
Things to Consider Before Taking a Loan Against Mutual Funds:
- Loan Amount and Interest Rates: Compare the loan amount offered by different lenders and their interest rates. Choose a lender that offers competitive rates and favourable terms.
- Loan Tenure: Consider the tenure of the loan and whether you’ll be able to comfortably repay the principal amount along with the interest within that period.
- No Loan Against Debt Mutual Funds: Yes, banks and NBFCs offer higher loan amounts on your debt mutual funds. However, it is better to avoid taking loans against the debt funds because the returns from debt funds are lower than loan interest rates. Better to sell your debt funds to cover your emergency requirements.
- Financial Discipline: Be honest with yourself about your ability to manage debt. Taking a loan against your mutual funds requires financial discipline to ensure timely repayments and avoid any adverse consequences.
- Explore Alternatives: Before finalising your decision, explore other alternatives for raising funds, such as emergency savings, liquidating non-essential assets, or even borrowing from friends and family.
Final Thoughts
A loan against mutual funds can be a useful tool for accessing liquidity without having to liquidate your investments. However, it’s essential to weigh the benefits against the risks and consider your financial situation carefully before proceeding.
While taking a loan against your mutual funds, limit your loan amount to 50% of your mutual fund value. Many NBFCs and FinTechs promote giving loans up to 80% but it will increase the chances of receiving a collateral call.
Remember, while it may offer a quick fix for immediate cash needs, it’s crucial to ensure that it doesn’t derail your long-term financial goals. As with any financial decision, do your research, seek advice if needed, and proceed with caution.
Want to know how to repay loans early? Read here.
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Still Curious?
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
ET Money – 6 Things to Know About Loans Against Mutual Funds
Mint – Don’t redeem, take a loan against mutual funds
ET Money – Loan Against Mutual Funds – A Complete Guide | How to Apply | Eligibility | Interest Rate
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.
