When there is urgent need of money for short tenures such as three months to a year, one option is to borrow against your mutual fund units. It is similar to an overdraft facility on a bank account, and the advantage is that you do not have to prematurely redeem your units, nor does your SIP get affected.
Take a look at the process and the type of funds that can be offered as collateral.
How can you get a loan against your mutual fund units? What would it cost?
Loan against your equity or hybrid mutual fund units could be taken from a bank or a non-banking finance company (NBFC) by pledging your mutual fund units.
You can pay back the loan at the interest rate agreed with the financier. Depending on the quantum of loan you take and the tenure, the interest rate could be in the range of 10-11 per cent on these mutual fund units. When the units are under lien, you cannot sell or switch the units.
Financial planners recommend taking on equity-oriented mutual funds and not against liquid or debt-oriented funds.
How does one apply for a loan?
Some online portals offer you loans quickly, if you hold units in demat form and have a prior approval. If you hold units in physical form, you first need to execute a loan agreement with your financier.
The financier will write to the mutual fund registrar and ask them to mark a lien on a certain number of units that are being pledged.
Financiers typically lend about 60-70 per cent of the value of the pledged units. The registrar in turn will mark the lien and a letter is sent to the financier with a copy to the investor confirming the marking of a lien on the units.
How can the lien on the mutual fund units be removed?
Once the loan is repaid by the borrower, the financier can ask for removal of the lien and send a request letter to the fund house. A financier can also request for a partial removal of lien in which case, lien on some of the units will be removed and these units are Rs free' units. This can happen when financiers receive part payments.
What happens in case of default?
In case the borrower defaults in making payment, the financier can enforce the lien i.e. send a signed request to the mutual fund to redeem the units and send the proceeds cheque to the financier.
What is the advantage of borrowing against your mutual fund units?
Loan against mutual funds gives you the option of receiving immediate liquidity against the mutual fund units that you own. It is like an overdraft facility for short-term monetary requirements, with a relatively shorter tenure than other loans.
It is a beneficial monetary tool for those looking to leverage their otherwise idle mutual fund investments, and also raise capital quickly for short -term financing needs. You need not sell your mutual fund units, hence your financial plan remains intact and neither is your ownership of fund units divested after pledging them for a loan.