Can Mutual Funds be Pledged?

At some stage of life, most of us might have encountered a phase where there was a need for funds for unplanned expenses. While we all have come across credit card loans, personal loans, or new-age products like buy now pay later loans (BNPL) but very few know about loans against mutual Funds. Let’s discuss it further in this article.

What is a Mutual Fund?

A mutual fund is a trust that pools money from several investors who share a common investment objective which is managed by a professional fund manager.  Mutual funds are ideal for investors who neither want to take huge risks nor have the time to research the market, yet want to grow their wealth. The money pooled by mutual funds is invested by professional fund managers in line with the scheme’s stated objective.

Can a Mutual Fund Be Pledged?

Yes, investors can use their mutual fund units as collateral to obtain loans from lenders such as banks & non-banking financial companies (NBFC). Investors will have to pledge their mutual fund units in favour of the loan provider, who then sets up a lien or legal claim over those units.

The loan amount against the mutual funds will depend on the Net Asset Value (NAV) of the mutual fund scheme units. For equity funds, investors may get around 50% (it may differ for different lending institutions) of the value of their holdings as a loan, while for debt funds investors may get up to 80% of the net asset value as a loan.

What Is The Procedure To Obtain Such A Loan?

Just like a house or gold is used as collateral to borrow housing or a gold loan, mutual fund units are used as collateral with banks. Each banking and financial institution has a list of mutual funds approved against which they are ready to give loans to individual investors.

The agreement is signed between the lending bank and investors to ensure that they do not withdraw money from the mutual fund scheme before completing their repayment to the lending institution. 

The lending bank or financial institutions like NBFC send a letter to the Registrar and Transfer Agency (RTA) seeking them to mark a lien on the mutual fund units for the loan. Following the verification and due diligence, the registrar will place a lien on the mutual fund units and send a letter to the lender, with a copy sent to the investor. After receiving the full loan amount with interest, the lender can ask the fund houses to release the lien on the mutual fund units. Investors can apply for loans either online or offline, depending on their preference. 

A lien is a claim or legal right against assets typically used as collateral to satisfy a debt. An investor cannot redeem these units as long as the mutual fund units are lien-marked. However, they continue to retain ownership of the units and enjoy all the associated benefits like dividends, bonus units, etc.

What Is The Interest Charged?

The loan provider charges interest on the investor’s loan amount or the utilized part of the approved limit. This interest rate charged against the loan is usually lower than the personal loan’s interest rate. In addition to interest rates, there are some additional charges like processing fees, annual maintenance fees, and renewal charges.

Standard Documents Required For Such Loan

1. Application Form
2. Passport Size Photograph
3. Pledged mutual funds detail
4. Latest income tax return copy
5. Id Proof- Aadhar, Driver’s license, Passport, voter card
6. Address Proof- Utility Bills/ Rent Agreement/ Passport/ Aadhaar Card
7. Income Document:

• Last 3 month’s salary slip
• Last 2 years form-16
• Last 6 months bank statement of salary account

Advantages of Loan Against Mutual Funds:

1. Provides you with instant liquid cash without redeeming your mutual funds.
2. Available at a lower rate than personal and other loans
3. Allows you to raise capital for your short-term financial needs.

How is Loan Against Mutual Funds better than Personal Loan?

Personal loans or credit card loans are unsecured loans as neither are they backed by security or collateral but a loan against mutual funds is a secured loan since lending institutions mark lien on the mutual fund units. Some key differences make a loan against mutual funds a better option than a personal loan but one should select which suits them best:

1. Low-interest rates

The interest rates of unsecured loans are usually higher than that of secured loans. Personal loans are given based on income while loans against mutual funds are given as per the percentage of the Net Asset Value of the funds. The rate of interest on a personal loan is very high and usually varies between 12 to 20% whereas the interest rate on a loan against mutual funds is between 8-12%.

2. Repayment terms

Pledging mutual funds ensures that the customer can avail of a loan on easy repayment terms, Lending bank ensures that there is no lock-in period or prepayment/ foreclosure charges and customers can opt for a flexible repayment schedule. However personal loan follows the equated monthly installment routine.

3. Credit score

A credit score is one of the first filters used by lenders to assess the creditworthiness of borrowers; especially in the case of unsecured personal loans. However, the eligibility criteria for a loan against mutual fund units is not dependent on the borrower’s credit score because of the pledged securities and involvement of lower LTV (Loan-To-Value)  ratios in loans against mutual funds. However, the credit score is checked to levy the appropriate rate of interest.

Conclusion

Loan against mutual funds is a great choice when there is an urgent short-term need for funds, you need not disrupt your financial plans.  Pledging your mutual fund offers you an opportunity to monetize your investments to raise capital for your personal/ business financing needs without having to sell them.

Frequently Asked Questions (FAQs)