You Have ₹20 Lakh in Mutual Funds. Would You Sell Your Units to Meet an
Emergency Expense of ₹10 Lakh?
Vivekanandan B, CFgP ®
Founder -
VRV FAMILY OFFICE,
94444
12260
ARN -
275665
A Guide to Loan Against Mutual Funds (LAMF)
Ramesh had
been investing regularly in mutual funds for the past ten years. Over time, the
current value of his investments had grown to ₹20 lakh. However, he suddenly
needed ₹10 lakh to meet expenses related to home repairs and medical treatment
for his family. Since he did not have sufficient money in his bank account, he
considered selling a portion of his mutual fund investments.
At that
point, a friend suggested, “Instead of selling your mutual fund investments,
you can consider taking a loan against them. There is a facility called Loan against
Mutual Funds (LAMF). Why don't you explore that option as well?”
That was
when Ramesh first learned about the facility of borrowing against mutual fund
investments.
Is it
possible to obtain money against your mutual fund investments instead of
selling them? Yes. One option is a Loan
against Mutual Funds (LAMF).
What Is a
Loan Against Mutual Funds?
A Loan against
Mutual Funds is a facility that allows investors to borrow money by pledging
their mutual fund units as collateral to a bank or financial institution,
rather than redeeming them. This facility generally falls under the broader
category of Loan against Securities (LAS).
The lending
institution evaluates the eligible mutual fund schemes and their current market
value before determining the loan amount. A lien is marked against the eligible
mutual fund units. This restricts the investor from freely redeeming or
transferring those units while the lien remains in place, subject to the terms
of the loan agreement.
How Much
Loan Can You Get?
Investors
should not assume that they can borrow the entire value of their mutual fund
investments. The eligible loan amount depends on the type of mutual fund
scheme, its market risk and the lending institution's policies.
Generally,
equity-oriented mutual funds may have a lower loan-to-value ratio, while
certain debt-oriented mutual funds may qualify for a higher ratio. However, the
actual limits vary from one lender to another.
For example,
if an investor has mutual fund investments worth ₹20 lakh and a lender offers a
loan limit of 50%, the eligible loan limit would be ₹10 lakh.
This is only
an illustrative example. It does not guarantee that a lender will offer a loan
of ₹10 lakh against the investment.
Selling
Mutual Fund Units vs Taking a Loan Against Them
|
Particulars |
Selling
Mutual Fund Units |
Loan
Against Mutual Funds |
|
Mutual fund units |
Units are sold or redeemed |
Units are pledged as collateral |
|
Repayment |
No loan repayment is required |
The loan must be repaid with interest |
|
Income tax |
Applicable capital gains tax rules may apply |
Borrowing alone is generally not treated as a sale of
investments |
|
Market risk |
The amount received from the sale is no longer exposed
to subsequent market fluctuations |
The value of the pledged investments may decline |
|
Major costs |
Applicable capital gains tax and exit load, if any |
Interest and other applicable charges |
How Does
the Loan Limit Work?
Some lenders
offer an overdraft facility against mutual fund investments. Under this
arrangement, the investor may use only the amount required from the approved
credit limit instead of borrowing the entire sanctioned amount.
Interest may
be charged based on the amount actually used and the period for which it
remains outstanding. However, investors should check whether minimum charges,
processing fees or other conditions apply.
What
Happens If the Stock Market Falls?
One of the
most important risks associated with a loan against mutual funds is market
volatility.
Suppose the
value of the pledged mutual fund units declines significantly. The collateral
may no longer provide sufficient coverage for the outstanding loan.
In such
circumstances, the lender may ask the borrower to pledge additional eligible
investments or repay part of the loan. This is commonly referred to as a margin
shortfall or margin call.
If the
borrower fails to meet the requirement within the stipulated period, the lender
may sell the pledged mutual fund units to recover the outstanding amount,
subject to the terms of the loan agreement.
Therefore,
investors should understand that borrowing against equity mutual funds does not
eliminate market risk.
Who Should
Consider This Loan?
This facility
may be worth considering for investors who have a temporary cash requirement
and a clear, reliable source of income to repay the loan within a reasonable
period.
However,
people with uncertain income, substantial existing debt or no clear repayment
plan should exercise considerable caution.
Not all
mutual fund schemes are eligible for this facility. Schemes that are not
included in the lender's approved list, certain closed-ended investments and
other ineligible schemes may not be accepted as collateral.
Investors
should confirm the eligibility of their specific mutual fund schemes with the
lender before proceeding.
Five Things
to Check Before Taking a Loan
1.
Interest Rate:
Compare the interest rates offered by different lenders, along with processing
fees and other applicable charges.
2.
Loan-to-Value Ratio: Confirm what percentage of the current investment value
can be borrowed against the eligible mutual fund units.
3.
Margin Risk:
Understand whether a market decline could require you to provide additional
collateral or repay part of the loan.
4.
Repayment Period: Decide when and from which source of income you will
repay the loan. Do not borrow without a realistic repayment plan.
5.
Investment Objective: Do not take a loan on the assumption that your mutual
fund investments will necessarily generate returns higher than the loan
interest rate. Market returns are not guaranteed.
Conclusion
A Loan
Against Mutual Funds can help investors meet immediate financial requirements
without having to sell their investments. However, it is not free money. The
borrower must pay interest and repay the loan, and a decline in the value of
the pledged investments could create additional financial pressure.
Before
deciding, investors should compare the tax implications and other costs of
redeeming mutual fund units with the interest, fees and risks associated with
borrowing against them.
Pledging
mutual fund units allows investors to retain their investments while accessing
funds, subject to the applicable terms and conditions. Once the loan is fully
repaid and the lender releases the lien, the investor regains unrestricted
access to those units.
The
key is to choose the option that meets the immediate financial need without
compromising long-term financial stability.
For More details and Investing..
Vivekanandan B, CFgP ®
NiSM
Certified Financial goal Planner,
Founder -
VRV FAMILY OFFICE,
94444
12260
vrvfamilyoffice@gmail.com
ARN -
275665,
