Availing of a Loan Against Mutual Funds? Make Sure You Borrow Wisely!
January 18, 2022 Mutual Fund
Mutual funds, as you may know, are a potent avenue for wealth creation. But, are you aware that when you are in urgent need of money—for whatever legitimate purposes—you can even avail of Loan Against your Mutual Funds?
The popularity of digital loans in recent years has been growing fast, and it’s extremely easy and convenient to borrow online by offering your mutual fund units as collateral. But how prudent is it, let’s understand in detail…
What is a Loan Against Mutual Funds and how does it work?
A Loan Against Mutual Funds is a type of loan against securities. It gives you the flexibility to access money from your investments in case of an exigency without having to redeem or sell your securities, in this case, your mutual fund investments.
It provides you with the option of utilising your mutual fund investments to avail a loan by pledging them to the bank or NBFC. The value of the loan you will be eligible for depends on the value of units held in your folio.
Since the mutual fund units are offered as collateral, redeeming the units pledged is not permitted unless you repay the loan in full. In case, you have ongoing SIPs (Systematic Investment Plans), your ensuing SIPs are not interrupted in the process.
Numerous banks and Non-Banking Financial Companies (NBFCs) today offer Loan Against Mutual Funds, both offline and online. A few digitally well-equipped banks, such as ICICI Bank, HDFC Bank, and SBI to name a few offer Loan Against Mutual Funds online without any paperwork. These loans are sort of pre-approved for a set of pre-qualified customers.
However, not all banks and NBFCs accept mutual funds managed by all the asset management companies (AMCs). For instance, SBI has been offering a loan against mutual fund units only to the investors of SBI Mutual Fund. Then, there are other leading banks that accept only the fund houses registered with Computer Age Management Solutions Private Limited (CAMS) — India’s largest mutual fund transfer agency.
For instance, if you have investments in any mutual fund registered with CAMS and hold a savings bank account with ICICI Bank, you are likely to be its pre-qualified borrower for Loan Against Mutual Funds. ICICI Bank has given an exhaustive list of approved mutual funds schemes across mutual fund houses. Going a step ahead, ICICI Bank clarifies that their pre-qualified borrowers need not have investments in mutual funds through its distribution code. The minimum Loan Against Mutual Funds one can avail of from ICICI Bank is Rs 50,000, while the maximum loan amount can be Rs 20 lakh in the case of equity mutual funds offered as collateral, and up to Rs 5 crore in the case of debt mutual funds.
HDFC Bank, too, offers a minimum loan amount of Rs 50,000, while the maximum is Rs 20 lakh against equity mutual funds and Rs 1 crore against debt funds. However, HDFC Bank allows the Loan Against Mutual Funds facility to their customers having investments with any of these fund houses: Aditya Birla Sun Life Mutual Fund, DSP Mutual Fund, HDFC Mutual Fund, HSBC Mutual Fund, ICICI Prudential Mutual Fund, IDFC Mutual Fund, Kotak Mahindra Mutual Fund, L&T Mutual Fund, SBI Mutual Fund, and Tata Mutual Fund.
How much loan you can get depends on the value of the mutual fund schemes you wish to offer as collateral. Usually, the Loan-To-Value (LTV) ratio is up to 50% of the Net Asset Value (NAV) in the case of equity funds; and up to 80% LTV in the case of debt mutual funds.
But what if you have mutual fund schemes that do not appear on the list of approved schemes of these leading banks?
You need not worry. Many new-age digital lenders such as Dhanlap (powered by Ark Neo Finance) can come to your rescue. Not only do they have schemes registered with CAMS, but also with KFintech, the other major RTA service provider for mutual funds.
The same holds true for some NBFCs such as Tata Capital and Bajaj Finserv offering loans against securities. Tata Capital offers you a loan from Rs 5 lakh up to Rs 20 crore, while for Bajaj Finserv, the threshold is Rs 10 crore.
When you need the money, availing of a Loan Against Mutual Funds has surely got its benefits…
- The loan can be availed of either offline or online.
- The application process is fairly simple compared to other loans.
- Compared to other types of loans, the approval and disbursement process is quick.
- You don’t have to liquidate or redeem your mutual fund units, and hence the planning for your long-term financial goals is uninterrupted.
- Your SIP instalments continue; thereby, not getting in the way of wealth creation.
- It serves as a useful means of credit, particularly when you do not have a credit history.
- The rate of interest charged on this type of loan is much lower than on a personal loan (an unsecured loan).
- Unlike a regular loan, there is no system of EMIs; you can pay at your convenience during the loan tenure.
- No charges are levied for prepayments.
As long as you are using the money for legitimate purposes, there is no restriction on channelizing the borrowed money. That being said, it is important that you follow a sensible approach when you avail of a Loan Against Mutual Funds.
When should you apply for Loan Against Mutual Funds?
You may consider borrowing against your mutual fund investments only when you are in dire need of money and you do not wish to liquidate your investments and/or discontinue your SIPs assigned for certain other envisioned financial goals. Borrowing against your mutual fund holdings to take advantage of market volatility must be strictly avoided.
Also, be careful while borrowing when the markets are near their peak, asset prices have surged, and the value of mutual fund holdings has gone up. Although, it may facilitate you to avail of a higher amount as a loan, on the flip side if the asset prices decline you may be subject to a margin call (asked to pay margin money) or asked to furnish more securities as collateral, plus you would have to bear the high interest cost involved.
When the markets are near a high and your investment value has appreciated, instead of redeeming a portion of your mutual fund investments (particularly the ones that have underperformed), may be a better option.
It is advisable to borrow when markets have fallen considerably and asset prices are down. Although, you may not be able to avail of a higher amount of loan, at least the risk is sort of reduced. You might avoid the loss that you would otherwise incur by selling mutual fund units at a lower price. And when the markets move up again, you would not be subject to a margin call or asked for more collateral since your mutual fund investments may have also fared better with the underlying asset prices increasing. That said, if the markets and asset prices unexpectedly drop further, you might be required to pay a margin or offer more mutual fund holdings/securities as collateral.
Similarly, be careful while offering debt funds as collateral. Entities, such as the IL&FS, DHFL, Reliance ADAG, Yes Bank, Essel group, among others defaulting on their debt papers and many debt mutual fund schemes facing the brunt, is a harsh reminder that investments in debt mutual fund schemes aren’t safe.
If the debt mutual fund schemes you hold have poor portfolio characteristics, it may weigh down on the scheme’s performance and you might have to offer additional collateral or pay margin in case your debt fund pledged to avail a loan incurs losses.
Now consider this example. Imagine you borrowed in January 2020 against Quantum Long Term Equity Value Fund (QLTEVF) when the average Net Asset Value of the scheme was around Rs 54.
Graph 1: Performance of Quantum Long Term Equity Value Fund
NAV data as of January 14, 2022
(Source: ACE MF, PersonalFN Research)
Soon after, within the next two months, the scheme’s NAV went below Rs 40 owing to the impact of the COVID-19 pandemic on the Indian equity markets. You may have felt the jitters, of course, and to add to your woes, the lender may have raised a margin call or asked for more collateral. But thankfully the markets scaled up—peaked to their lifetime high—thereafter, the fund value moved up, and it possibly alleviated many concerns.
But had you to borrow against the same fund today near the peak of the Indian equity markets when valuations look stretched, and there are headwinds in play on account of the third wave of the pandemic plus monetary policy normalization in the western world; the risk of availing of a Loan Against Mutual Funds is far higher. It may potentially rock your boat without any prior notice.
Graph 2: Performance of Quantum Gold Fund ETF
NAV data as of January 14, 2022
(Source: ACE MF, PersonalFN Research)
Today, if you were to avail of a Loan Against Mutual Funds, perhaps it makes sense to do so against a Quantum Gold Fund – Exchange Traded Fund (ETF). This is because, price of gold, which is the underlying for gold ETFs, has fallen nearly -15% since the peak of August 2020. And against the backdrop of the third wave of COVID-19, its impact on GDP growth, the ballooning debt-to-GDP ratio of many nations, rising inflation, and escalating geopolitical tensions, gold just might display its traits of being a safe haven, a store of value, and an effective portfolio diversifier. It may not be a good time to sell your gold ETF or gold savings fund unit at this point if you need the money. On the contrary, take a loan against them, since the price of gold in Indian rupee terms may not fall too much; it would remain relatively stable and it is a sensible thing to do. If gold exhibits sheen, i.e. the price of gold rises due to the aforesaid factors, the value of your investment in gold ETF or gold savings fund would also amplify, thereby not nudging the lender to raise a margin call or ask for more collateral.
As long as the Reserve Bank of India (RBI) maintains the policy rates unchanged and ample liquidity fails to find many borrowers; such types of loans might continue to be offered at around 10%-11% interest per annum.
How to apply for Loan Against Mutual Fund?
Here are general steps to apply for Loan Against Mutual Funds online:
Visit the official website of the bank or NBFC you would like to borrow from. Every bank and/or NBFC could follow a slightly different process.
DhanLap—powered by Ark Neo Finance–helps you get Loan Against Mutual Funds in around 15 minutes. All you have to do is:
-
✓ Sign-up for free, share your personal details (name, address, age, contact numbers etc.)
-
✓ Submit your documents (a Consolidated Account Statement of your mutual fund portfolio)
-
✓ Choose the investments you wish to mark a lien on
-
✓ Check the terms & conditions
-
✓ And you receive the money digitally
It is as simple as that; seamless and no tedious paperwork involved.
When and how to close a Loan Against Mutual Fund?
On diligent repayment of the loan in full, the fund house removes the lien on your mutual fund units on request from the lender. Once the lien is removed, you can have full access to your mutual fund investments. Many lenders allow part-payment of loans. In that case, the lender will free up some units depending on the amount you’ve partly paid.
And if you’re unable to repay the loan, the lender requests the fund house to redeem the mutual fund units and receives the outstanding dues out of the redemption proceeds.
To conclude:
These days due to an increased awareness by the banks and NBFCs, Loan Against Mutual Funds has become a popular choice of credit. That said, before you avail of a Loan Against Mutual Funds, carefully evaluate the purpose for which you need the money, how you plan to repay, and make sure you thoroughly read all the terms and conditions.
In case of a financial emergency, Loan Against Mutual Funds can be one of your options, rather than liquidating your mutual fund portfolio. However, you need to carefully assess the market level and conditions before you avail of a Loan Against your Mutual Funds.
Happy Investing!
This article first appeared on PersonalFN here
