Just like personal loans offer a way to access quick funds, there is another option that taps into the value of your existing investments – loans against mutual funds.
This process involves pledging units of mutual fund schemes to a lender in exchange for a sanctioned loan amount. It allows the investments to remain in the borrower’s name.
Through this credit method, first-time borrowers or people with low credit scores can obtain loans without paying a high interest rate.
What does pledging mutual funds mean?
Pledging your mutual funds means using your investments as security for your loan.
Instead of selling your units during an emergency or cash crunch, you can borrow money against them and pay yearly interest only on the borrowed amount.
How is it different from personal loans?
A personal loan is unsecured, and banks or lenders offer loans based on income and credit score.
However, the interest rate on the loan is determined by the borrower’s credit or CIBIL score. A lower CIBIL score, typically between 300 and 550, attracts a higher interest rate, whereas a higher CIBIL score, typically above 750, attracts a lower interest rate.
In the case of pledging mutual funds, the lender provides the loan amount based on the value of the person’s holdings. As in the case of personal loans, the borrower’s credit score does not necessarily determine the interest rate of the loan.
“Credit firms usually don’t have a minimum credit score criterion for loans against mutual funds or stocks because it’s already secured,” said Kapil Nagal, head of Volt Money.
The interest rate depends on the lender and the performance of the pledged funds. The interest is calculated daily and deducted monthly, with the borrower only paying interest on the utilised amount.
How to determine if it’s the right option for your needs?
According to Nagal, pledging mutual funds can be an easy and quick way for first-time borrowers without a credit score to get a loan.
He added that, contrary to applying for a personal loan, which requires many documents and is time-consuming, loans against mutual funds are a quick way of getting urgent money.
Many banks specify the amount you can borrow against your mutual funds. It also depends on the type of fund that you are putting as collateral.
“Loans aren’t usually sanctioned for new fund offers (NFO) or a mutual fund scheme whose overall asset management is very low,” said Nagal.
According to market standards, you can receive loans up to 50% of the value of pledged equity fund units and 70%- 80% of the value of pledged debt fund units.
Banks and NBFCs offering this facility
Several public sector banks (PSUs) and well-known private banks offer loans against mutual funds. HDFC, SBI, ICICI, Axis and Bank of Baroda are to name a few.
On the other hand, several non-banking financial institutions (NBFCs) also have the same provision. Tata Capital, Bajaj Finserv and Volt Money are a few NBFCs offering these loans.
Here are some banks that provide both personal loans and loans against mutual funds with their respective interest rates.
Interest rates for salaried borrowers
| Banks | Loans against MF (per annum) | Personal loans (per annum) |
|---|---|---|
| SBI | 10.10% | 10.30%-15.30% |
| HDFC | 6.75%-10.13% | 10.90%-24% |
| ICICI | 10.75%-11.75% | 10.75%-19% |
| Axis | 11.49%-13.75% | 11.25%-22% |
| Bank of Baroda | 9.90%-11.25% | 10.90%-18.50% |
Source: Official bank websites
Risks and considerations
Experts also emphasised that the borrower must be aware of the costs involved, even after the loan is sanctioned.
Nagal spoke about margin-shortfall and how the borrower must take responsibility for it.
For instance, if a borrower pledges funds worth ₹1,00,000 and gets 50% of its value as a loan, which is around 50,000 on a particular day, then after a few weeks, if the same funds’ value reduces to ₹95,000 due to a market downturn, then the borrower should pay the shortfall to the lender within 6 days. In this case, the shortfall is ₹2,500.
“If the borrower fails to pay the shortfall amount within the given time, the lender will retrieve twice the amount by selling some pledged funds,” said Nagal. This deducted amount is later adjusted in the principal loan amount, but some units from your mutual funds will be gone, he added.
The borrower must also be aware of the costs involved, such as the interest and the processing charges, said Nirav Karkera, the Head of Research at Fisdom Securities. “The person must also know that they will not be able to redeem their mutual funds until the entire debt is paid off”
If the borrower defaults on a loan against mutual funds, the lender can sell the pledged mutual fund units to recover the outstanding loan amount. If the sale amount is insufficient to cover the debt, the borrower remains liable for the remaining amount.