5 Rules for Taking a Loan Against Mutual Funds

A loan against mutual fund is a convenient option for individuals with a mutual fund portfolio. It allows one to take a loan against securities they hold and pay interest only on the utilized amount. If one needs urgent funds like a medical emergency or any other unexpected expenses, they don’t need to sell their securities or dig more into their saving. They can simply take a loan by pledging their securities against it.  

This blog explores the guidelines one needs to follow when it comes to taking a loan against mutual funds and their repayment terms.   

What is Loan Against Mutual Funds?   

A Loan Against Mutual Funds is a financial arrangement that allows the borrower to get a loan by pledging their securities like bonds, stocks, and mutual funds to the lender. While the borrower retains ownership of the pledged assets, their mutual funds continue to grow and give them returns. However, the borrower cannot sell the pledged securities till the loan tenure is completed. 

The lender decides on the loan amount based on the percentage market value of the pledged securities. They also factor in the borrower’s credit score, type of securities and the current state of the stock market

Loan against Mutual Fund offers a flexible loan option compared to other types of loans like personal loans, credit cards, etc. It is particularly beneficial to individuals who have built a well-established portfolio. It gives them instant access to funds to utilize for an emergency or other such expenses without the need to liquidate assets. 

How does Loan Against Mutual Funds Work?

If you have a demat account, you get to invest in securities and you get to take a loan against securities. The benefit of taking a loan against mutual funds is that your securities continue to grow and give you returns. Here is how loans against mutual funds work: 

• Works like Tradition Loans: A loan against mutual funds works just like traditional loans. When you apply for this type of loan, the lender decides on the loan amount based on various factors including market value of your pledged securities. 

• Profit & Returns: The main advantage of a loan against mutual funds as compared to any other types of loans, is that: you continue to earn returns on your pledged securities. You continue to receive any profit, dividends, and bonuses on the pledged securities throughout the loan tenure. You enjoy the perks of mutual fund returns all while simultaneously taking a loan against it. 

• Smart financial strategy: In times of urgent financial need like a medical emergency or relocation, you don’t have to sell your stocks or dig into your savings. A loan against mutual funds allows you the option to continue to hold ownership over your securities while taking a loan. This allows you to manage your finances without any added burden. 

Also Read: Different Types of Mutual Funds Based on Various Categories

5 Rules to Follow While Applying for LAMF   

If you are considering a loan against mutual funds, it is important to understand the terms and follow proper guidelines to ensure a stress-free borrowing process. Here are a few key guidelines to follow when you consider loan against mutual funds:  

• Choose the Right Lender: It’s important to compare lenders and select the one that offers the option to pledge different types of securities against the loan. Additionally, if you have a diverse portfolio, it increases your chances of loan approval and may help you secure a higher loan amount. 

• Check & Understand Eligibility: Before you apply for any loan, it is important to understand loan eligibility and ensure to fulfil it. Make sure you fulfil the age criteria, credit score, employment status, and have the correct documents required by the lender. 

• Understand Loan-To-Value Ratio (LTV): The Loan-to-value ratio is the metric lenders use to determine the loan amount as against the value of the pledged securities. Ensure you check the lender’s LTV requirements before applying for the loan. 

• Check for Hidden Charges: It is important to check for any hidden charges before taking any loan against a mutual fund. These charges include processing fees, maintenance fees, etc. Being aware of these charges will help you effectively manage your repayment efficiently. 

• Impact on Investments: Evaluate the potential impact of pledging your mutual funds for a long tenure. The market value of the mutual funds may change and if it decreases, you may need to pledge additional collateral to maintain the loan-to-value (LTV) ratio.

What are Repayment Terms and Options for LAMF?   

Repayment terms for loans against mutual funds varies from lender to lender. Here are the common terms for loan against mutual fund: 

• Loan Term: The lender offers tenure anywhere between 12 months to 60 months, giving the borrower flexibility in repayment. 

• Repayment Frequency
  • • Monthly Instalments: You pay a fixed amount per month that includes principal and interest amount. 
    • Interest-Only Payment: Some lenders allow you to pay only the interest (monthly or quarterly) throughout the loan term with the principal amount paid at the end of the loan term. 
• Pre-payment charges: Some lenders may allow you to prepay the loan amount before tenure without any pre-payment charges. Some lenders may charge prepayment charges. You need to check with your lender regarding these charges before you apply for the loan against mutual fund. 

• Loan Default: If, for any reason, you are unable to make payments, the lender has the right to sell or liquidate your pledged securities, to recover the loan amount. 

Also Read: Direct vs Regular Mutual Fund – Which is Better?

Conclusion  

When you consider taking a loan against mutual funds, it is important to understand the terms of each lender. Compare and assess which lender best suits your financial goals. Follow the guidelines to make an informed decision when taking the loan. As the market value of mutual funds may increase or decrease as per market conditions, it is advisable to choose more liquid funds to pledge to the lender.