Loan Against Mutual Funds: Pros and Cons

When an individual makes an investment decision in a mutual fund, they usually have a long-term investment horizon. Despite allocating funds and making financial plans, there might be situations where one might require additional funds, leading them to sell their mutual funds. However, individuals can stay invested and get funds by taking a loan against mutual funds. Along with knowing what it is, one should also learn about the pros and cons of a loan against mutual funds. Read on as we explore this in more detail.

What is a Loan Against Mutual Funds?

A loan against mutual funds is similar to any other secured loan, in which a loan is given against collateral or security. For example, a gold loan is a type of loan where one can borrow money against the gold that they own.

Similarly, a loan against mutual funds is a type of loan in which an individual can pledge their mutual fund units to avail a loan. In a loan against a mutual fund, the bank or financial institution gives out a loan which is a certain percentage of the investment value.

For example, if your mutual fund’s investment value is ₹1 lakh, a bank might give you a loan of ₹85,000 (85%).

Advantages of a Loan Against Mutual Funds

Quick Liquidity Without Redemption

One of the key advantages of a loan against mutual funds is that it allows one to avail funds without redeeming their mutual funds. The quick liquidity option can be extremely helpful when one requires funds quickly.

Lower Interest Rates

Taking a loan against mutual funds can be helpful as the interest rates are lower compared to other sources, such as personal loans or credit cards. The lower interest rate charges can easily be offset if your investment continues to grow.

Simple Process

Applying for a loan against a mutual fund is a simple and straigthforward process. The process can be completed online with minimal documentation, such as PAN and Aadhaar.

Income Proof Requirements

One of the pros of a loan against mutual funds is that, unlike a personal loan, it does not require income proof. Many lenders do not ask for income proof since the loan is given against the mutual fund units.

Flexible Repayment Options

Repaying a loan against mutual funds can be convenient, with numerous options available. Some lenders do not charge a foreclosure fee, making it easier to repay the loan.

Investment Continues to Grow

The major advantage of a loan against a mutual fund is that your investment continues to grow during the loan tenure. The growth in investment value can not only offset the interest charges but may also allow you to repay the loan easily in the future.

Disadvantages of a Loan Against Mutual Funds

Risk of Fund Liquidation on Default

If you have taken a loan against a mutual fund and fail to repay the loan amount and default, the bank or financial institution may sell the mutual fund units to recover the pending charges.

Mutual Fund Eligibility

Although banks and financial institutions accept a large number of mutual funds to be pledged, there might be some limitations. Typically, only equity, debt, and hybrid mutual funds are eligible for loans against mutual funds, While ELSS funds are eligible after the lock-in period is over

Impact of NAV Fluctuations

When you’re applying for a loan, the amount you can borrow depends on the net asset value (NAV) of the mutual fund. When the NAV is higher, the value of your mutual fund increases, allowing you to borrow more. On the other hand, a lower NAV reduces the total amount of money you can borrow.

Processing Fees & Charges

Before applying for a loan against a mutual fund, it is important to check the processing fees and charges. Sometimes, these hidden costs can accumulate or result in unnecessary expenses.

Limited Loan Tenure

One of the disadvantages of a loan against mutual funds is that it may not be suitable for borrowers looking to borrow funds for a longer duration. The maximum tenure is 36 months and minimum is 12 months usually.

Loan Against Mutual Funds vs. Personal Loan – Which is Better?

Both personal loans and loans against mutual funds can be a vital source of financial assistance in times of need. A loan against mutual funds is beneficial since it does not require income proof or a high credit score in most cases. The interest rates are also lower and allow the borrower to stay invested. Although a personal loan can offer higher loans for a longer tenure, the interest rates are relatively higher.

When Should You Opt for a Loan Against Mutual Funds?

A loan against mutual funds can be suitable when you require quick liquidity without selling your investments for any short or long- term capital needs.

A loan against mutual funds is also helpful when your NAV has declined. Borrowing at a lower NAV can be beneficial in the long run as the value of the mutual fund increases.