A friend in need is a friend indeed. People often turn to friends when they need help, sometimes even for money.
But when the amount involved is large — for whatever purpose — there are broadly two options: liquidating some investments or borrowing from a bank.
Liquidating investments early may not always be the right decision. Doing so could make it harder to achieve the financial goal for which the investments were made.
An alternative is to take a loan against securities such as mutual funds or stocks. This allows the investments to remain in place while providing access to funds.
In recent weeks, tensions in the Middle East have led to declines in equity markets. As a result, selling equity mutual funds or stocks now may not yield the amount you expect, particularly if you started investing recently.
If you have invested for a longer period, selling investments can also trigger tax liabilities. Depending on the holding period, investors may need to pay short-term capital gains or long-term capital gains tax when redeeming mutual funds.
There is also an opportunity cost.
Selling investments interrupts the effect of compounding, especially when the mutual fund schemes or stocks have delivered steady performance.
Even with current market pressures, long-term returns from Indian markets may remain positive. If that happens, the underlying investments could continue to grow over time.
India remains a major emerging market for investment and is one of the fastest-growing economies.
History shows that Indian equities have delivered gains over time despite wars, military conflicts, financial crises and market scandals. These include the Kargil conflict, the Russia-Ukraine war, tensions in the Middle East and the India-Pakistan conflict in May last year.
During periods of geopolitical uncertainty, investors who stayed invested often saw better outcomes than those who exited markets during volatility.
If you need funds during such periods, a loan against mutual funds or other securities can provide liquidity without selling investments. Interest rates in the Indian economy are currently relatively low.
Interest Rate On Loan Against Mutual Funds In India
The interest rate on loans against mutual funds usually ranges between 9% and 11.5%, depending on the bank or lending institution.
Because this is a secured loan, the rate is typically lower than a personal loan, which is unsecured.
Unlike many other loans, borrowers usually have flexibility in repayment. Banks generally do not require fixed equated monthly instalments. Borrowers can decide how much to repay and when.
Interest is charged only on the amount used from the sanctioned loan. This prevents borrowers from paying interest on the unused portion.
The Amount Of Loan Against Mutual Funds You Can Avail
Borrowers can typically obtain 50% to 80% of the investment value as a loan.
For equity mutual funds, the Reserve Bank of India recently increased the maximum loan limit from Rs 20 lakh to Rs 1 crore to support credit availability. However, banks generally maintain a loan-to-value ratio of about 50% for equity funds to manage market risk.
For loans against debt mutual funds — which invest in listed debt securities such as corporate bonds and debentures — the Reserve Bank of India has removed the ceiling limit. The loan-to-value ratio for debt funds has increased to 75% from the earlier 50%.
Assume a mutual fund portfolio valued at Rs 28.5 lakh invested across equity and debt funds, as follows
In such a case, equity mutual fund holdings could generate a loan of about 50% of their value, or Rs 13 lakh. Debt fund holdings could generate a loan of about 75% of their value, or about Rs 1.87 lakh.
In total, the investor could raise slightly more than Rs 14.87 lakh, subject to processing fees.
Processing fees generally range between 0.5% and 1% of the loan amount. Some lenders charge a flat fee, which may range from Rs 500 to Rs 5,000 depending on the lender.
Investors do not need to pledge the entire mutual fund portfolio. They can choose specific funds against which to take the loan.
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Follow Sensible Approach
A loan can provide access to funds when required, but borrowers should approach it carefully.
Consider a loan against mutual funds only when funds are necessary and when you do not want to redeem investments or stop systematic investment plans meant for specific financial goals.
Avoid pledging mutual funds set aside for long-term goals such as retirement or a child's education.
Borrow only the amount required. In volatile market conditions, lenders may issue a margin call — asking the borrower to add funds or pledge additional securities if the value of the pledged mutual funds declines.
If markets recover and the value of investments rises, the likelihood of such margin calls reduces and repayment becomes easier.
If a mutual fund scheme consistently underperforms, investors may consider redeeming it rather than pledging it for a loan.
Managing debt carefully and using investments with discipline can help individuals manage financial pressure during uncertain periods.
Happy investing.
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