A loan against ELSS mutual funds helps you pledge your holdings as collateral to obtain loans seamlessly without having to sell them. This comes in handy whenever you have to meet urgent financial needs. Let’s learn more about these loans below.
What is an ELSS Mutual Fund?
ELSS mutual funds are equity mutual funds that help investors save taxes while potentially growing their wealth through market investments. You can get tax deductions up to ₹1,50,000 under Section 80C of the Income Tax Act on your investments, which also come with a mandatory lock-in period of three years. It is important to note that a loan against ELSS mutual funds can be availed only after the lock-in period ends.
Features of an ELSS Mutual Fund
Some key features of ELSS mutual funds include the following:
- You can get tax deductions up to ₹1,50,000 under Section 80C of the Income Tax Act
- A minimum of 80% of the assets of the fund will be invested in equities and other equity-related instruments
- The mandatory lock-in period of three years is shorter than many other tax-saving options
- Skilled fund managers professionally manage funds
- After the lock-in period, the returns will be taxed as long-term capital gains (LTCG). If they surpass ₹1,25,000 in a year, they will be taxed at 1.25%
Can You Take a Loan Against ELSS Mutual Funds?
Now comes the most significant question: can I take a loan against ELSS mutual funds? The answer is a resounding yes. It is, however, a loan against ELSS post lock-in that you can avail of. This means that once the lock-in period is over, you can pledge your units as collateral to a bank or NBFC to avail a secured loan without selling off your investments.
How to take a Loan Against ELSS Mutual Funds after a 3-year lock-in
Here is a round-up of the process to take a loan against mutual fund units:
- Check the eligibility of your specific ELSS fund and whether it’s on the lender's approved list for loans.
- You can log in to your NBFC/bank app or portal and initiate the loan request against the funds.
- The next step is authorising the digital lien marking on the mutual fund units in favour of the lender. This is done through the RTA (Registrar and Transfer Agent), such as KFintech or CAMS (via OTPs).
- Receive, examine, and e-sign the loan agreement, while establishing the mandate for repayment (primarily for monthly debits of interest).
- Once the lien is confirmed, the amount will be disbursed seamlessly to the bank account.
How Loan Against ELSS Works (After Lock-in)
Understanding ELSS loan eligibility and documentation requirements is essential before applying. After the three-year lock-in period, the units will be liquid and may be used as collateral.
The NBFC/bank will put a lien on the mutual fund units. You cannot sell/transfer them until you completely repay the loan. The amount is usually between 50% and 75% of the market value or NAV (net asset value) of the units you pledge. This is known as the LTV or loan-to-value ratio.
The rate of interest applicable to a loan against an ELSS mutual fund is usually lower than that for credit cards or personal loans, among other unsecured loans (since they are secured loans).
You will retain ownership of your units while benefiting from dividends and market appreciation during this period. You will repay the loan amount with interest, or choose flexible terms such as paying monthly interest only on the amount utilised.
Upon full repayment, the lender will remove the lien, giving you complete control to redeem/sell them or stay invested.
Things to Know Before Applying for a Loan Against ELSS
Here are some things you should know before applying for a loan against ELSS mutual funds:
- The interest rates are often lower than unsecured loans (usually around 10-11% per annum or likewise)
- The value of the collateral will change with the market. If the value of the pledged fund units declines, the lender may issue a margin call. You will have to repay a part of the loan amount or pledge more units to maintain the LTV ratio.
- The interest repaid is not tax-deductible, unless it is used for particular business purposes. Capital gains on the units will be taxed only when you sell them.
- Many lenders offer zero foreclosure and prepayment charges for these loans. You should carefully review these aspects before investing.
Benefits of Loan Against ELSS Mutual Funds (Post Lock-in)
Some of the advantages of a loan against ELSS India include the following:
- Your investment continues to grow without you having to sell off your pledged units. You will retain ownership and earn potential returns and dividends throughout the loan tenure.
- These are secured loans, meaning the interest rates are much lower than those for unsecured loans. Also, the loan process is quick and requires minimal paperwork.
- The loan process is primarily digital, and funds can be disbursed swiftly, often within hours or 1-2 business days.
- Pledging the units is not taken as redemption/sale, keeping you free from immediate STCG or LTCG.
- Many lenders offer flexible repayment options, such as paying only the interest on the amount you use (similar to an overdraft facility). Some also offer the choice to prepay loans with zero or negligible foreclosure charges.
Risks of Loan Against ELSS Mutual Funds
Some of the risks of these loans include:
- ELSS funds primarily invest in equities, so the NAV fluctuates with market movements. If the value of your pledged units falls well below the LTV ratio, there will be a margin call. You will need to provide additional collateral or partially repay the loan to maintain the required margin.
- Failure to meet margin calls or default on loan repayments will result in the forced liquidation of the pledged ELSS units to recover the lender’s outstanding dues. It may often be done at unfavourable prices, leading to higher losses.
- Once the units are pledged, you cannot switch these units or redeem/sell them. It leads to reduced flexibility when you want to rebalance your portfolio in response to evolving market conditions.
- The loan is only available once the three-year lock-in period concludes.
Tax Implications for Loan Against ELSS Mutual Funds
The tax implications of loans against ELSS mutual funds are the following:
- Pledging units as collateral does not equate to a sale/redemption, thereby not triggering any capital gains taxes.
- The interest amount is not tax-deductible unless you use it for specific business objectives.
- The loan amount is not subject to income taxes.
- In the event of any default, lenders will sell the pledged units to recover their dues. This will attract capital gains taxes based on the holding period.
