Today, we have an interesting topic to talk about. Most of us would have faced a situation where there is an unexpected, unplanned & urgent need of funds. In such confusing times, our go-to source of money is our investments made for long-term goals. What if we tell you that there is a way where your long-term goals are not sacrificed, and money was made available to you the same day. Yes, there is a way, Loan Against Mutual Funds.
In this article, we will explain all about loan against mutual funds and why it is a good option compared to redeeming.
If you have investments in mutual funds and have an urgent need for funds, you may consider taking a loan by lien marking your mutual fund holdings. The loan amount will depend on the Net Asset Value (NAV) of the mutual fund scheme units that you will lien and the type of scheme. For equity and hybrid funds, you may get around 50% (it may differ for different lending institutions) of the value of your holdings as a loan, while for debt funds you may get around 70-80% of the value as a loan. The lending institution (e.g. Bank, NBFC) will ask the Registrar and Transfer Agency (RTA) to mark a lien on the mutual fund units for the loan. You will not be able to redeem units or make switches as long as the units are lien marked. However, you still continue to retain ownership of the units and enjoy all the associated benefits.
Personal loans or credit cards are unsecured loans i.e., they are not backed by security or collateral. Loan against mutual funds is a secured loan since you lien mark your mutual fund units. There are some key differences between the two and one should select which suits them best.
The interest rates of secured loans are lesser than that of unsecured loans. If you need a loan and have mutual fund investments, you can reduce your interest expenses by lien marking your mutual fund units instead of taking a personal loan.
You may not get a personal loan or pay a very high rate of interest if you do not have a credit history. On the other hand, you can get loan against mutual funds even if you do not have a credit history.
Personal loans have a fixed EMI which is principal plus interest and customers are supposed to service the same every month. In most loan against mutual funds you service only the interest every month and get the flexibility to repay the outstanding principal amount anytime during the loan tenure.
Most personal loans also come with a lock-in period, prepayment & foreclosure charges. In loan against mutual funds, there is no lock-in period or prepayment/ foreclosure charges. Customers can make payments anytime at their convenience.
You have the option of redeeming units of your open-ended mutual fund schemes if you are in need of funds. However, in some cases, taking a loan by lien marking your mutual fund schemes may be a better option. For example, if you are in urgent need of funds in a volatile market, taking a loan is a better option than redemption as you may have to redeem at lower NAVs. Furthermore, redeeming also affects your financial plan which in turn affects your long-term financial goals. Redemption may also attract a short-term capital gain tax or long-term capital gain tax.
When you lien mark your mutual fund units you continue to retain ownership of your investments. You continue to get returns (e.g. capital appreciation, dividends) on the units lien marked for the loan. Once you have closed the loan account, the lien will be removed from your pledged units and its NAV may have also appreciated. If you have invested in IDCW option, you will continue to receive dividends or IDCW payments even on your pledged units. You can also continue your Systematic Investment Plans in folios, where you have pledged lien on units. You can free up lien units once you close your loan account.
Life can throw unexpected surprises at you. You need not disrupt your financial plans if you have an urgent short-term need for funds. You can think loan against mutual funds as emergency funds. You can use this facility to meet your short-term needs, while you continue on your plans for different financial goals.
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