A loan against mutual funds means using the value of your mutual fund investments as collateral to secure a loan from a financial institution. It is a way to get money without selling your investments. This strategy has several benefits but also comes with some risks and considerations. Here are 8 things to know about loan against mutual funds:
1) Loan amount is limited by your investments
The amount you can borrow depends on the type of mutual fund you have and the current value of your investments. Different funds have different levels of risk and stability. For example, equity funds, which invest in stocks, are riskier and may allow you to borrow less money compared to more stable debt funds.
Moreover, the current value of your mutual fund investments affects the loan amount. If the market is down and your fund’s value is lower, you might get a smaller loan. If the market is up and your fund’s value is higher, you could borrow more.
2) Every bank has specific rules
Not all banks offer loans against every mutual fund. Banks assess the risk and liquidity of different mutual funds. Moreover, some banks may have partnerships with specific mutual fund companies, influencing which funds they accept as collateral.
Many banks only accept specific mutual fund schemes for loans. For example, equity funds can change in value a lot, making them riskier. So, banks might only approve loans against certain equity funds that they find less risky.
3) Lower interest rates
Loans against mutual funds have lower interest rates compared to credit card loans or personal loans. Because they are backed by your mutual fund investments as collateral.
Secured loans have lower interest rates because they are less risky for the lender. When you use your mutual funds as collateral, the bank has a claim on your investments. If you can’t pay back the loan, the bank can sell your mutual funds to get their money back. So, this lower risk allows banks to offer lower interest rates.
In contrast, personal and credit card loans are unsecured. Therefore they carry higher interest rates to compensate for the increased risk.
4) There are limits on loan against mutual funds
Banks set both maximum and minimum amounts for these loans. Even if you have substantial investments, a bank will only lend up to a certain percentage of your funds’ value, known as the loan-to-value (LTV) ratio.
Each bank also has its maximum loan cap, regardless of the LTV ratio, to manage its risk. Additionally, banks set minimum loan amounts to cover processing and management costs.
5) Continued earning on your pledged mutual funds
When you pledge your mutual fund units to get a loan, those units stay invested in the market and continue to earn returns. The bank can only sell your mutual fund units if you fail to repay the loan.
As long as you make your payments on time, your investments remain in the market and keep growing. You get the loan amount while your mutual fund investments continue to work for you. So you will benefit from any market gains and dividends during the loan period.
6) Easy online application for overdraft against mutual funds
You can easily apply online to get an overdraft limit set in your bank account using your mutual fund investments as collateral. This process is quick and convenient, giving you fast access to funds.
Many banks let you apply for an overdraft through their online platforms or mobile apps. So, you don’t have to go to a bank branch. Once your application is approved, the bank sets an overdraft limit on your account, which you can use whenever needed.
7) Minimal impact on credit score
Taking a loan against your mutual funds usually doesn’t hurt your credit score much because it is a secured loan. If you can’t pay back the loan, the bank can sell your mutual funds to recover their money.
Additionally, making your payments on time helps maintain a stable credit score. It will be beneficial if you plan to apply for other loans in the future.
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8) Flexible repayment options
Loans against mutual funds often come with flexible repayment options. For instance, you might be able to pay back the principal amount at the end of the loan period while making regular interest payments.
This flexibility helps you manage your cash flow better, especially if your income varies or you have other financial obligations. You can adjust your repayments to fit your financial situation, reducing stress.
Final words
Taking a loan against your mutual funds can be a good way to get money while keeping your investments. However, it is important to consider the pros and cons and explore other financing options before deciding. By understanding the details of borrowing against mutual funds, you can make informed financial choices.
