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Loan against mutual fund: Is it better than redemption?

During emergency, you have the option to either sell some of your mutual fund investments, or take loan against your it. In this article, we will understand what is better taking a loan or redemption?
Loan against mutual fund: Is it better than redemption?

Most investors maintain an emergency fund with 3-6 months of income. However, at times, there can be a large emergency funding requirement for which the emergency fund may not be enough. During such times, you have options like going for a personal loan, selling some of your mutual fund investments, or availing a loan against your mutual fund investments. From the above options, availing of a loan against your mutual fund investments can be your best option. In this article, we will understand what is a loan against a mutual fund and how it is better than redemption. Let us start by understanding what is a loan against a mutual fund.

What is a loan against a mutual fund?

A loan against a mutual fund is a loan offered by banks and NBFCs against the security of your mutual fund units. The bank or the NBFC takes the borrower’s MF units as collateral and offers an overdraft facility. The borrower can use the amount from the loan account as and when required. The interest is charged only on the utilised amount. The borrower can repay the loan amount at any time.

Usually, banks and NBFCs offer loans against equity mutual fund units up to 50% of the value and against debt mutual fund units up to 80% of the value. The loan against mutual fund units is a secured loan, and hence the interest rate on it is lower than a personal loan. The interest rate charged on loans against mutual fund units is usually 10-12% p.a.

Why is a loan against a mutual fund better than redemption?

An investor has a choice to either redeem the mutual fund units or take a loan against them. Usually, taking a loan is better than redeeming mutual fund units. Some of the reasons for this include:

  1. Redemption can lead to exit load: In case of some mutual fund units, if they are redeemed before a specified time, there can be an exit load. But, if an investor goes for a loan, she need not redeem the MF units, and hence there will be no question of exit load.
  2. Tax implications: If equity mutual funds are redeemed within one year, and debt mutual funds are redeemed within three years, short-term capital gains (STCG) tax will apply. But, if an investor goes for a loan, she need not redeem the MF units, and hence there will be no question of paying STCG or LTCG.
  3. Disruption of financial goals: If an investor redeems her mutual fund units, her financial goals will suffer. But, if the investor goes for a loan against mutual fund units, her investment portfolio will continue to grow, and she will be able to accomplish her financial goals.
  4. Benefits from retaining the mutual fund portfolio: When an investor goes for a loan against mutual fund units, she continues to retain the investment portfolio. She will continue to benefit from the appreciation in the net asset value (NAV) of the units. She will also continue to receive the dividends if any, as and when they are declared.

Application and removal of a lien:

Before we understand the application procedure of a loan against mutual fund units, it is important to understand the concept of lien. A lien is applied to your mutual fund units when you avail of a loan against your MF units. With the lien, you will not be able to redeem the mutual fund units until the lien is removed. 

The rights on the mutual fund units will be transferred to the bank till the loan is repaid. If you default on the loan repayment, the bank can sell the MF units and recover the outstanding loan amount. Once you repay the loan, the bank will ask the MF registrar to remove the lien, and you will be able to use the mutual fund units the way you desire.

Procedure for loan against mutual fund units

To avail of a loan against mutual fund units, you need to make an application to the bank, either online or submit an application at the bank branch. The application will include your personal details, loan amount, and the details of your mutual fund units. The bank will instruct the mutual fund's registrar, such as CAMS, to mark a lien on the mutual fund units. The registrar will mark a lien and inform the bank and the borrower. The bank will then open an overdraft facility for the borrower.

Not all banks and NBFCs give loans against mutual fund units. Among the ones that do, they may give the loans against the mutual fund units of specific AMCs only. Banks and NBFCs have minimum and maximum amounts they can give as a loan against MF units. The loan tenure is usually one year, post which you can renew it.

Your mutual funds can be your saviour during difficult times

In the above sections, we have seen how taking a loan against MF units is better than redeeming mutual fund units. So, the next time you have any short-term financial emergency, you can always rely on your mutual fund portfolio to sail you through the difficult time with an overdraft loan.

Goal planning with the Glide Invest App

In the above section, we saw how you could take a loan against your mutual fund units rather than redeem them. You can partner with the Glide Invest App to get recommendations for the appropriate mutual fund schemes based on your risk profile. You will get advice on planning and systematically investing towards your financial goals

With Glide Invest, you will get guidance for:

  1. A personalised risk profile assessment
  2. Identifying your financial goals
  3. Appropriate asset allocation
  4. Making a financial plan for each goal
  5. Automating the financial plan
  6. Review and analysis of your financial plan 
  7. Hand holding you till your financial goals are achieved

To start investing towards your financial goals, download the Glide Invest App from Google Play Store or Apple App Store and get started.

Keywords

  1. Financial emergency
  2. Loan against securities
  3. Loan against mutual fund
  4. Redemption
  5. Mutual funds
  6. Net asset value
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