How will you benefit from investing early in mutual funds?

We often hear about loans against a property or a home or even against some amount of gold. But taking a loan against investments are not very common in this country. However, some banks and non-banking financial institutions (NBFC) offer loans against investments in mutual funds. You can get a loan up to 10-12 times your investment. These loans, however, carry interest rates ranging between 9.5% and 14%. Tata Capital is the newest player in the block to offer loans against mutual funds.

The processing period is small and the interest rate is lower than personal loans.

The process

Like other loans where a house or gold or even property is kept as security to lend money, in this case, mutual fund units in demat accounts are kept as collateral with banks.

Each bank and NBFC has a list of approved mutual funds against which they would give loans. Mutual funds other than the enlisted one are not eligible as collateral.

To apply for such a loan, investors first need to enter into an agreement with the bank and the mutual fund house that sells the fund in case the investor is unable to pay dues in the future.

This agreement gives rights to the lender to sell the funds if a borrower is unable to pay. The agreement is signed to ensure that the investors do not redeem money from the mutual fund scheme before they repay the lender.

Amount

Like all other loans the amount of loan depends upon the security you pledge to take the loan. The type of funds that you own determines the loan value.

Generally, for equity or hybrid mutual funds the loan amount is a bit lower than debt funds. On the other hand, the loan margin for equity and hybrid fund is generally 50%, where for debt fund this is merely 20%.

Typically, one can get up to 80% of the total investment value on debt funds and 60% of the total amount in equity funds. Equity oriented mutual funds invest in shares of companies while debt funds invest in fixed income securities like government securities, bonds and so on.

Some banks may offer 60% loan amount of the net asset value of the funds while another may give 70%.

Interest rate

The interest rate on these loans generally goes up to 14%. They start from 9.5%. Rates of interest for such loans are typically more than 10% per annum across lenders, but there is a scope to negotiate interest rates.

If you have a good credit score, you might get the loan around 10%-11%. Banks generally charge lower than NBFCs.

Pros and cons

There are multiple reasons for you to opt for a loan against mutual funds. These loans give you immediate liquidity against your investment in mutual funds. It allows you to raise short term capital requirements and that too without redeeming your investments.

If you even invest in a debt fund it will give at least 9%-10% annual return and an equity fund might give you a 15% return. So, the interest rate of the loan, i.e. 10%-14% is almost compensated by your earnings. So, your loan burden remains very low.

On the other hand, if your MFs produce a low return (i.e. below 9%) than the interest rate of the loan would be more than your returns from the MFs. If you fail to repay, the lending agency would take possession of all your investments.

Top lenders

Top public sector lender State Bank of India offers loans against mutual funds at a low rate of 9.75% per year. Major private lenders like HDFC, ICICI and Axis Bank also offer such loans to customers.

Besides large commercial banks, NBFCs such as Bajaj Finserv, Fullerton India, Aditya Birla Capital and Tata Capital, etc are also in this business.