Loan against mutual fund units may be better in case of any urgency because of lower interest rates compared to personal loans. But there are risks you should know
If you own mutual fund units, you can take a loan against them instead of going for a personal loan. While one should go for any kind of loan only when it can’t be avoided, borrowing against mutual fund units would make more sense in case of any urgency because of lower interest rates compared to personal loans.
However, there is a risk of borrowing against mutual funds that borrowers should know. Let’s understand this with an example.
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Suppose you pledge a part of your mutual fund units to get a loan from an NBFC or financial institution. The price of each unit pledged is higher at the time of borrowing but as the loan starts the price falls considerably. What will happen now?
Krishna Kanhaiya, CEO of Mirae Asset Financial Services, says that when the price of a mutual fund unit falls considerably, the borrower’s eligibility limit for the overdraft account drops. Further, if the revised eligible limit is less than the utilised amount then the account becomes overdue and needs to be regularised.
“If the value of the security drops considerably, in such an event the eligible limit of the overdraft account drops and if the revised eligible limit is less than the utilised amount then the account becomes overdue and needs to be regularised,” says Kanhaiya.
Borrowers should keep in mind the above risk before going for a loan against mutual funds. Further, there are several other important points that borrowers should factor in. In an email interaction with FE Money, Kanhaiya shared some of the key points that borrowers should know. Let’s have a look:
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Loan Details
Borrowers should be aware of the maximum and minimum loan amount, eligibility criteria, loan tenure, Loan to value (LTV), etc. These parameters directly impact the borrower and hence it is important to consider these parameters before selecting the lender from which he/ she aims to avail loan against mutual funds.
Cost of borrowing
One should first understand all charges and other details around the cost of borrowing. Borrowers often just look at interest rates and do not consider other charges like processing fees, prepayment charges, security de-pledging charges, penal interest rate, etc., involved while availing of a loan.
Repayment schedule and flexibility
Another important parameter is to understand repayment terms. Flexibility in repayment structure eases the burden, for example, with a loan against mutual funds, you can repay the principal amount anytime during the loan tenure. The borrower just has to service the interest amount monthly. This gives borrowers a lot of flexibility where their money inflows are ad-hoc.
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Approved list of mutual funds
Different lenders have a different approved list of mutual funds against which they provide credit. Some lenders have only CAMS-registered funds, and some lenders have approved mutual funds only from a few AMCs. At times some mutual funds are not part of the approved list as they are undergoing a merger, changing RTA or based on some internal risk parameters. Most lenders do not provide loans against close-ended mutual funds or funds where units are under a locked-in period (Eg: Locked in units of ELSS funds, fixed maturity plans, etc.)
Impact of changing value of investment
With a volatile market scenario, it is possible that the value of the underlying asset undergoes an increase or decrease in value. The borrower should clearly understand how this change in value affects the value of the loan. Also, in the case of a fully utilised account, how it will affect the borrower and what option he/ she has to regularise the account.
Application process and Other processes
One should also check how easy it is to execute other activities like de-pledging of mutual funds, changing contact information, changing of bank accounts, top-up of existing loans, etc. Often availing a loan is easier however closure of a loan or any service task with regard to an account is tedious and time-consuming.
