Borrowing Against Mutual Fund Units
Borrowing against Mutual Fund investments is a quick avenue available for mutual fund investors to tide over short term financial crunches. Lenders extend finance against the value of units on which lien is marked in favour of the lender by the investor. Banks and Non-Banking Finance Companies are active players in this segment.
Advantages of borrowing against mutual fund investments
The advantages of borrowing against mutual fund units are many as far as investor is concerned.
1. Competitive interest rate. Interest rate depends on market conditions. Since the loan is secured by pledging mutual fund units, the interest rate is much lesser than unsecured personal loans, loans offered by credit cards etc.
2. Easy process and documentation – Many online portal make borrowing against units in demat form very easy.
3. Investor need not redeem the units prematurely and hence his financial planning remains intact.
4. Investor can continue the Systematic Investment Plan (SIP).
5. No tax on short term/ long term capital gains as units are not redeemed.
Cost associated with borrowing against mutual fund units
The major cost you have to bear is the interest on the amount of borrowing. In the prevailing market conditions, the rate of interest on borrowing against mutual funds could be around 11%. The rate varies depending on the interest rate in markets and also the MCLR of lending banks. It is always advisable to consult two or three lenders to get the best rate. Banks and Non-Banking Financing Companies like HDFC banks, Kotak Bank, Bajaj FinServ, IIFL, Axis bank, ICICI Bank etc are aggressive in financing against mutual funds.
Apart from interest, you may also have to meet one time charges like processing fee, documentation charges, lien noting and releasing charges. Proceed only after getting proper clarifications on various associated charges.
The interest charged on the loan is higher compared to return on investment in debt funds. Hence, availing loan will be beneficial to the borrower if his investment is in equity or hybrid schemes where the return is higher.
How can an investor borrow against mutual fund units?
There are many lenders that offer loan against your investment in mutual funds. Also some online portals extend pre-approved loans against Mutual funds. This is extended against units held in demat form. The advantage of pre –approved loan is that once approved, you can avail the amount at any time.
If the investment is held in physical form, then you have to approach a lender and they will request the mutual fund registrar to note lien on the units. They will confirm it back to the lender under intimation to the investor and thereafter the lender will sanction loan to you. Normally 50% of Net Asset Value (NAV) of your investment is sanctioned as loan.
Maximum amount that may be sanctioned and margin stipulations by a lender vary depending on many factors like volatility in the market, internal policies of the lender and stipulations by the regulator.
What happens in case of default of loan against mutual fund?
Lien marking by lender means creating his charge on the investment. This gives the financier the right to hold the units as security for the loan extended to the borrower. The financier gets the right to sell the units if warranted. If the investment is in joint names, lenders insist that all joint holders must agree for noting the lien and execution of loan documents. Once lien is noted, the investor will not have freedom to sell or switch his investment without consent from the lender. If the borrower fails in repayment, the lender may sell the units in market and realize the amount loaned. On the other side, after repayment of loan by the borrower, a letter will be issued by the lender to mutual fund registrar confirming repayment of loan and requesting to release the lien. The investor can thereafter handle the investment freely.
