A loan against mutual funds allows investors to borrow money by pledging their mutual fund holdings as collateral. Instead of selling the mutual fund units to access funds, investors can keep their investments intact while availing of the loan. The lender places a lien on the mutual fund units, which prevents the borrower from redeeming or selling them until the loan is fully repaid.
The loan amount is typically determined based on the loan-to-value (LTV) ratio set by the lender. The LTV ratio represents the percentage of the mutual fund's net asset value (NAV) that the lender is willing to lend. LTV ratios usually range from 50% to 80%, depending on the lender's policies and the type of mutual funds being used as collateral.
Borrowers can use the loan amount for various purposes, such as:
- Meeting urgent financial needs
- Funding a large purchase
- Managing temporary cash flow shortages
- Taking advantage of investment opportunities, and more
Interest rates for loans against mutual funds are generally lower than unsecured loans like personal loans because mutual funds serve as collateral, reducing the lender's risk. However, borrowers must be aware of the potential risks involved. It includes any impact on the growth of their investments and the risk of default leading to the liquidation of their pledged units.
To apply for a loan against mutual funds, borrowers need to meet certain eligibility criteria set by the lender. The mutual funds being pledged should be eligible for loan purposes according to the lender's guidelines, and borrowers must provide relevant documents and complete the loan application process.
Taking a loan against mutual funds can be an effective financial tool for those in need of immediate funds while preserving their investment portfolio's long-term growth potential. However, borrowers should carefully evaluate the terms and conditions, interest rates, repayment schedule, and potential risks associated with the loan before proceeding. Consulting with a financial adviser can help borrowers make an informed decision that aligns with their financial goals and circumstances.
