Pledging mutual funds? Keep extra units handy to handle margin calls

Previously, availing these loans was a cumbersome physical process that took five-seven working days

Loans against mutual funds (MFs) are gaining traction among retail investors, who now recognise the value of staying invested for the long term. Rather than redeeming MF units during a cash crunch, many are opting for loans against them. 

Growing popularity 

Previously, availing these loans was a cumbersome physical process that took five to seven working days. “Now, the loan is available digitally and you can avail it in a short while from your home or office,” says Krishna Kanhaiya, chief executive officer (CEO), Mirae Asset Financial Services. 

Kanhaiya adds that the rise in systematic investment plan (SIP) contributions has created a pool of long-term MF assets that can be pledged for loans. 

Market downturns once triggered widespread redemptions. “Increasingly, people do not want to sell their MF units during market downturns and have instead started opting for this loan. This ensures their wealth continues to compound. Equity MFs have the ability to offer 12–15 per cent compound annual growth rate (CAGR) over the long term,” says CR Chandrasekar, founder and CEO, DhanLap. 

Borrowers are turning to secured options as unsecured personal loans become harder to access amid credit tightening. “Personal loans, especially the small-ticket ones, are getting harder to get. A secured loan against an asset costs less than a personal loan and gets approved more easily,” says Adhil Shetty, CEO, Bankbazaar. 

Cheaper than personal loans 

Kanhaiya informs that interest rates on these loans range from 10 to 14 per cent. “We charge 10.5 per cent per annum, irrespective of client profile or loan size,” he says. 

Chandrasekar informs that DhanLap charges 10.5–11 per cent. 

Some lenders offer this loan as an overdraft facility. “Borrowers are provided a limit. They can withdraw according to their requirement and repay according to their cash flows. There is no fixed monthly EMI. Interest is charged monthly on the utilised amount. Principal does not have to be repaid each month and can be paid at the borrower’s convenience,” says Kanhaiya. 

Another benefit is zero foreclosure charges. “No penalty is charged if you close the account. The lien on MF units is lifted within 24 hours,” says Kanhaiya. 

Beware margin calls 

Market volatility can erode the value of pledged securities, triggering margin calls. “In extreme circumstances, a portion of assets could be sold to meet the margin call,” says Chandrasekar. Shetty warns that the borrower could lose his assets if he defaults. Returns from equity funds are not assured. “In some years, the rate of interest on the loan would exceed the return from your MF units,” says Chandrasekar. 

Who should go for them? 

Long-term investors stand to benefit from these loans. “Investors facing short-term emergencies or liquidity issues may go for these loans,” says Abhishek Kumar, Securities and Exchange Board of India (Sebi) registered investment adviser and founder, SahajMoney. 

The EMI-based versions require monthly repayment of principal and interest. “Those who cannot pay the EMIs would be better off selling their MF units,” says Chandrasekar. 

Kumar suggests keeping extra MF units or cash handy to meet margin calls in case of market decline. He warns against taking this loan to fund impulse purchases.  

He also suggests maintaining emergency funds to avoid having to borrow at all.

 

Borrower’s Guidebook

 

*  Look for a transparent lender: One that discloses the terms and conditions of the loan on its website without customers having to reveal personal details

 

*  Check all key terms of the loan: Interest rate, loan-to-value (LTV) ratio; and charges like processing fee, service charge, and renewal cost

 

*  Lenders usually allow up to 50 per cent LTV for equity MF loans (lower than the 75 per cent on gold loans)

 

*  Each lender has its own list of approved schemes; ELSS, which have a lock-in period, may not qualify