Loan Against Mutual Funds- Know These Pitfalls

Availing a loan against your mutual funds’ investment is quite an easy process today. You have to just pledge your mutual funds units to the institution and in return, the Institution release the money you have requested.   The ease is so much now that today you don’t need to visit a branch.

Loan Against Mutual Funds Few institutions have launched this service digitally where you have to provide details and amount is credited to your account as an overdraft facility. With so much ease surely the interest generates when you are in need of money.

Loan against mutual funds is a short-term loan. Generally, the loan period is of one year. The bank or institution will request the registrar like Cams, Karvy or Franklin Templeton to mark a lien against the mutual funds’ schemes you have added in the collateral. One of the main benefits of this loan is that your eligibility does not depend on your credit behavior. Instead, the loan eligibility depends on the collateral i.e. mutual funds.

Small investors will not be aware of this option but investors with a large amount of investment have been utilizing this. But as banks go digital to provide this loan it is expected that many of us will be made aware of loan against mutual funds.Though it’s an easy loan to avail there are many reasons which go against it.

Here are some of them to be understood and keep it as a last resort if nothing is available:

The Cost

The first aspect to analyze in any loan is the cost. How much you pay to the bank to utilize the credit. Any loan which demands a higher rate of interest is not considered to be a good loan. Loan against mutual funds is also a high-interest loan. The interest rates at different institution range from 11-15%. Beyond this, there are many other charges which will add to your cost. A processing fee of .5-2%, Annual maintenance fee, custodian fee etc .. will be charged during the loan period.  Add all these costs and you will find the cost almost equivalent to a personal loan. Then why not avail a personal loan and save your mutual funds from any collateral.

The Loan To Value

One of the large drawbacks of loan against mutual funds is that you have to keep a high collateral for a reasonable amount of loan. The amount of loan against mutual funds’ investments varies between equity and debt mutual funds scheme. In equity, institutions offer 50% of the value of units and in debt 70-80% of the value of units as a loan. What this means is that more equity in your portfolio lesser the loan amount you will receive. So for a Rs 1 lakh loan, you will have to pledge units worth Rs 2 lakh if it’s a complete equity portfolio. Not many investors hold debt mutual funds scheme in their portfolio.

You Cannot Sell

When you invest in mutual funds schemes you look for growth which will help in meeting your objectives. When this growth will come no one is sure. It’s only during an emergency that you may think to keep your mutual funds’ investments as collateral. Now imagine during your loan period you see the growth in your investments which you were waiting for. Had your mutual funds’ units not been under collateral you would have sold them and met your requirements? Thus when your mutual funds’ investments are under lien period you cannot sell them unless you repay the loan. This can work against you when you realize that the growth would have saved you from paying a high cost to the institution. When your mutual funds’ investments have appreciated to a good value offering them as collateral may not work.

What If You Default?

When you availed this loan you were already under financial stress. It’s reasonable to think that default on interest payment can happen if you experience more financial trouble. In such a scenario the institution will demand instant payment of the loan. If you are unable to pay the institution will sell mutual funds investments you have kept as collateral and will recover their loan. It is a double blow considering that you were already in financial stress and now you lose your mutual funds investments too.

All the above reason are highlighted to make you understand when a loan against mutual funds may not work.  Experts advise that any high-interest loan should be a last resort knowing that it may cause more financial troubles for you. The advice is well suited for a loan against mutual funds. When you have analyzed all option and does not see any of them available to you then only consider this loan.

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