'If the portfolio growth rate is higher, take this loan. If it is lower, liquidate your investments.'
Only 59 per cent of the equity investments owned by retail investors are held for more than 24 months, according to data from the Association of Mutual Funds in India.
Medical and other emergencies lead to early liquidation. One way investors can avoid doing so is by taking a loan against mutual funds (LAMFs).
Key features
The MFs offered as collateral must be held in demat format.
"The lender verifies whether the funds belong to its approved list," says Adhil Shetty, CEO, Bankbazaar.
Lenders usually offer a loan to value (LTV) ratio of 45 to 50 per cent for equity funds and 75 to 85 per cent for debt funds.
The interest rate is usually between 10 and 16 per cent, but can sometimes go higher.
"New-to-bank customers and those with poor credit history are charged higher rates," says Shetty. The rate also depends on the riskiness of the collateral.
Keep long-term investments
This loan allows an investor's long-term investments to grow.
"If you have a portfolio with an expected annual rate of return of 12 to 15 per cent, and can avail LAMF at 10.5 per cent, it makes sense not to liquidate the portfolio," says Krishna Kanhaiya, director & CEO, Mirae Asset Financial Services.
Redeeming an equity fund before one year gives rise to short-term capital gains tax (15 per cent) and an exit load, which can be avoided by taking this loan.
"LAMF does not come with any end-usage restrictions," says Sahil Arora, chief business officer (secured lending), Paisabazaar.
These loans are usually offered as an overdraft (OD) facility.
"Borrowers can draw from their sanctioned limit according to requirements and repay in tranches. They can withdraw as many times as they like and do not incur prepayment charges," says Arora.
Interest is charged only on the amount used and for the number of days it is used.
Beware of market fluctuations
MFs invest in market-linked instruments whose prices fluctuate. Lenders revalue the pledged units regularly.
A sharp fall in their net asset value can lead to the loan amount exceeding the LTV ratio.
Lenders then issue a margin call, asking customers to pledge more fund units or pay in cash.
"If the customer fails to do so within seven days, the lender can liquidate the pledged funds," says Arora.
The excess amount is treated as overdue.
"It attracts overdue charges at 15 per cent per annum plus GST till it is regularised," says Kanhaiya. Failure to pay also affects the borrower's credit score.
Should you go for it
Compare the interest rate on this loan with the likely growth rate of your portfolio.
"If the portfolio growth rate is higher, take this loan. If it is lower, liquidate your investments," says Shetty.
Those taking these loans must have resources to fall back on.
"If the lender asks for additional collateral, the borrower must be able to provide it," says Abhishek Kumar, a Sebi-registered investment advisor and founder, SahajMoney.
Kanhaiya suggests not utilising 100 per cent of the loan limit to avoid margin calls.
Kumar adds one should maintain an emergency fund to avoid taking this loan.
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Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
Feature Presentation: Ashish Narsale/Rediff.com
