How to Apply for Loan Against Mutual Fund?

A mutual fund is one of the most popular investments tools in India and has grown substantially of late. If you look at the retail participation via Systematic Investment Plan (SIPs) and in terms of number of folios, the contribution of retail investors to mutual funds is huge. However, one important consideration for investors in any asset class is liquidity.

Liquidity is not only in terms of the ability to sell in the market but also the ability to leverage and raise loans by hypothecating the assets. For example, property, gold or equities can be easily pledged to raise funds. What about mutual funds? Can an investor pledge mutual fund units and get a loan? That is actually possible. Apart from various benefits of mutual funds investment, you can also avail loan against your mutual fund holding.

Borrowing against a mutual fund is better than a personal loan

Quite often we all resort to taking a personal loan or taking a loan against our demat account when need short term money. However, there are lot of doubts and misconceptions about borrowing against mutual fund holdings. Many investors are still doubtful if they can actually take loans against their mutual fund holdings. The answer is in the affirmative and investors can absolutely borrow against their mutual fund units too.

There are a few basic things to know here. Banks will typically lend against open ended funds only and not against closed ended funds. Normally, banks don’t lend against ETFs or exchange traded funds as they are called. Similarly banks are also averse to lending against your holdings of international funds, asset allocation funds, fund of funds or sectoral funds. It is actually easiest to get loans against diversified equity funds and against your debt fund holdings. Here is how you can go about getting loan against mutual fund holdings. In terms of cost, it works out much cheaper than a personal loan, which is an unsecured loan.

ARE THERE ANY ADVANTAGES OF TAKING LOANS AGAINST MUTUAL FUNDS?

Borrowing against a mutual fund holding is better than redeeming your units when you need short term funds. Quite often it happens that you tend to redeem some of your units when in need of short term funds. However, that has a downside risk. It carries the risk of disrupting your long term financial plan. An easier way would be to take a loan against your mutual fund holdings, by just giving your bank / NBFC lien on your mutual fund holdings.

The big advantage is that your holdings stay intact and once the loan is repaid in full, you get your mutual fund units released. The cost of such funds is also lower. So, your long term financial plan is intact and your cost of borrowing is much lower. Just to compare; a typical personal loan may come at an interest rate of 16-18% since it is unsecured. However, loans against mutual funds come at a much lower interest rate of around 10-11%. If you have a long relationship with the bank or if you have a very high credit score, you can get still better terms.

CAN YOU EXPLAIN THE PROCESS FLOW OF GETTING LOAN AGAINST MF UNITS

It roughly operates like overdraft facility that bank accounts offer. You can avail loan against equity or hybrid mutual funds by approaching any non-banking financial company (NBFC) or bank. Normally, the credit score is not very important although it does matter, despite being a secured loan. However, you have to pledge your mutual fund units as security for the debt and the lender gets . The loan amount will be decided based on the value of units in the folio and the tenure you choose.

Like in gold loans, even in loan against mutual fund units the concept of loan-to-value or LTV is used? There is something that Loan to value (LTV) standards that most banks follow. Such LTV is 50% in case of equity funds and 80-85% in case of debt funds. That means if you have equity fund holdings worth Rs.1 lakh, you borrow up to Rs.50,000 against these holdings. As the value of the portfolio appreciates, you avail top-up if you so require. In case of debt funds, limit is higher considering the lower volatility risk in debt funds. Once the assessment is done and the units are pledged, you can get the loan within a day or two.

PLEDGING MUTUAL FUNDS UNITS TO THE LENDER IS MANDATORY

Let us spend a moment on understanding the concept of lien on mutual funds. Lien is a document that gives the bank the right to sell the fund or hold it, in the event the borrower defaults on the loan commitment, which could either be interest or principal commitment. While the units are still in your ownership, since they are pledged to the lender you cannot sell the units till the lien is lifted. Once the loan is repaid, the lien is lifted and then you are free to sell the units. For a loan against equity funds of Rs.500,000 you will have to lock in units to the tune of Rs.10 lakh as lien with the bank. You need to approach your fund AMC and request for a lien on your units in the name of the bank and pledge appropriate units. In case of multiple holders, all the unit holders must sign the request letter for lien transfer in the same order of ownership.

WHERE TO AVAIL THESE LOANS AGAINST MUTUAL FUNDS?

It is a lot simpler if the AMC also has a group banking arm. For example, if you have mutual funds of AMCs with a group banking outfit like ICICI Pru, HDFC, Kotak and SBI; they even offer online loan against mutual fund holdings through your net banking facility. You can also approach online portals which actually sanction loans quickly if units are in the demat form. In case of physical units, a loan agreement with the NBFC or the lending bank should be in place.

The lender instructs the mutual fund registrar (CAMS or KFINTECH) to mark a lien on the number of units pledged. The registrar verifies the document and then marks the lien and sends a letter to the lender with a copy to the borrower confirming the lien. The lien is marked against units, and not amount. You cannot redeem the pledged units before you fully repay the loan. Of course, you are free to sell the non-pledged units at will.

WHAT IS THE PROCESS OF REPAYING LOAN AGAINST MUTUAL FUNDS?

Once the loan is repaid, the financier again sends a request to the fund house or to the registrar to lift the lien and process the loan closure document. You can also enforce partial removal of lien by making part payment, if that is acceptable to the lender as per the terms of the contract. In such situations, partial units will be freed while the rest would still be under lien. In case the borrower defaults, the lien can be enforced and the lender is entitled to sell the pledged units and redeem the same with the fund house. Apart from losing your units, such defaults also result in weakening of your credit score.

Borrowing against mutual fund units is a good way to monetize idle fund holdings without being required to sell the same. It allows you to keep your SIPs and your financial plan intact and at the same time raise funds at a much lower cost.