Loans against mutual funds have become quite popular in recent times due to the many benefits that they offer. Mutual funds are investment instruments that pool money from different investors and invest it in various financial assets like stocks, bonds, and money market instruments. These funds are managed by professional fund managers who make investment decisions on behalf of the investors.
A loan against mutual funds is a type of secured loan that allows investors to borrow money against their mutual fund units. The loan amount is usually a percentage of the value of the mutual fund units pledged as collateral. Here are six things you need to know about loans against mutual funds:
1. Loan amount and interest rate
The loan amount that you can get against your mutual fund units depends on the value of the units you pledge as collateral. Typically, you can get a loan of up to 50-60% of the value of the mutual fund units pledged. The interest rates on loans against mutual funds vary from lender to lender but are usually lower than unsecured loans like personal loans and credit cards. The interest rate for these loans can range from 9-12% per annum.
2. Tenure of the loan
The tenure of the loan against mutual funds can range from 1-5 years. The repayment schedule of the loan is usually monthly, and the loan can be repaid in equal installments. Borrowers can also prepay the loan, but there may be a prepayment penalty charged by the lender.
3. Credit score and eligibility
To get a loan against mutual funds, you need to have a good credit score. Having a good credit score increases the chances of getting a loan approved, and you may also get a lower interest rate. The eligibility for a loan also differs from lender to lender, and it also depends on the value of the mutual fund units pledged. Some lenders may also require the borrower to have a minimum income or net worth criteria.
4. Advantages of loan against mutual funds
One of the significant advantages of a loan against mutual funds interest rate is lower compared to unsecured loans. The loan also provides liquidity to the borrower without having to liquidate the mutual fund units. The borrower can continue to hold onto the mutual fund units and participate in any future appreciation in value. Another advantage is the quick processing time of the loan, as many lenders offer instant approvals and disbursements of the loan amount.
5. Risks and drawbacks
Like any other loan, a loan against mutual funds also carries some risks and drawbacks. The borrower needs to ensure that the mutual fund units pledged as collateral are not sold or redeemed during the loan tenure. If the value of the mutual fund units pledged as collateral falls below the loan amount, the borrower may be asked to provide additional collateral or repay the loan partially or completely. Additionally, if the borrower defaults on the loan, the lender can sell the mutual fund units pledged as collateral to recover the loan amount.
6. Tax implications
Taking a loan against mutual funds does not have any tax implications for the borrower. The loan amount is not considered as income, and hence, there is no tax liability on the borrower. However, if the mutual fund units pledged as collateral are redeemed or sold during the loan tenure, capital gains tax may be applicable. Moreover, if the borrower defaults on the loan, the lender may sell the mutual fund units, which may result in capital gains tax liability for the borrower.
Conclusion
The loans against mutual funds have become a popular financing option for investors due to the many advantages they offer. They provide liquidity to the borrower without having to liquidate the mutual fund units, have lower interest rates compared to unsecured loans, and offer quick processing times. However, borrowers need to be aware of the risks and drawbacks associated with these loans and ensure that they do not default on the loan.
