Planning Loan Against Mutual Funds?

'The rise in SIP contributions has created a pool of long-term MF assets that can be pledged for loans.'

Loans against mutual funds (MFs) are gaining traction among retail investors, who now recognise the value of staying invested for the long term.

Rather than redeeming MF units during a cash crunch, many are opting for loans against them.

Growing popularity

Previously, availing these loans was a cumbersome physical process that took five to seven working days.

"Now, the loan is available digitally and you can avail it in a short while from your home or office," says Krishna Kanhaiya, CEO, Mirae Asset Financial Services.

Kanhaiya adds that the rise in systematic investment plan (SIP) contributions has created a pool of long-term MF assets that can be pledged for loans.

Market downturns once triggered widespread redemptions.

"Increasingly, people do not want to sell their MF units during market downturns and have instead started opting for this loan. This ensures their wealth continues to compound. Equity MFs have the ability to offer 12 to 15 per cent compound annual growth rate (CAGR) over the long term," says C R Chandrasekar, founder and CEO, DhanLap.

Borrowers are turning to secured options as unsecured personal loans become harder to access amid credit tightening.

"Personal loans, especially the small-ticket ones, are getting harder to get. A secured loan against an asset costs less than a personal loan and gets approved more easily," says Adhil Shetty, CEO, Bankbazaar.

Cheaper than personal loans

Interest rates on these loans, Kanhaiya informs, range from 10 to 14 per cent.

"We charge 10.5 per cent per annum, irrespective of client profile or loan size," he says.

Chandrasekar informs that DhanLap charges 10.5 to 11 per cent.

Some lenders offer this loan as an overdraft facility.

"Borrowers are provided a limit. They can withdraw according to their requirement and repay according to their cash flows. There is no fixed monthly EMI. Interest is charged monthly on the utilised amount. Principal does not have to be repaid each month and can be paid at the borrower's convenience," says Kanhaiya.

Another benefit is zero foreclosure charges.

"No penalty is charged if you close the account. The lien on MF units is lifted within 24 hours," says Kanhaiya.

Beware margin calls

Market volatility can erode the value of pledged securities, triggering margin calls.

"In extreme circumstances, a portion of assets could be sold to meet the margin call," says Chandrasekar. Shetty warns that the borrower could lose his assets if he defaults. Returns from equity funds are not assured.

"In some years, the rate of interest on the loan would exceed the return from your MF units," says Chandrasekar.

Who should go for them?

Long-term investors stand to benefit from these loans.

"Investors facing short-term emergencies or liquidity issues may go for these loans," says Abhishek Kumar, Sebi registered investment adviser and founder, SahajMoney.

The EMI-based versions require monthly repayment of principal and interest.

"Those who cannot pay the EMIs would be better off selling their MF units," says Chandrasekar.

Kumar suggests keeping extra MF units or cash handy to meet margin calls in case of market decline. He warns against taking this loan to fund impulse purchases.

He also suggests maintaining emergency funds to avoid having to borrow at all.