You can get a loan against your MFs, but be wary of the caveats

Systematic investment plans through MFs are the best way to meet your long-term financial goals. (iStockphoto)
Systematic investment plans through MFs are the best way to meet your long-term financial goals. (iStockphoto)

Summary

Redeeming MF units could attract capital gains tax and disrupt the compounding process

Systematic investment plans through mutual funds (MFs) are the best way to meet your long-term financial goals. Financial planners or advisers will vouch for that. Yet, not many retail investors stay committed to their long-term plans. Only 54% of retail money remained invested in equity mutual funds for more than two years in 2020, as per data from the Association of Mutual Funds in India. The rest was redeemed for various reasons. Notably, investors do have the option of borrowing money against their MF units. Not many are exercising this option. Thus, a very small fraction of assets under management of the MF industry has been pledged. Firms like Bajaj Finance and Mirae Asset Financial Services, and startups such as VoltMoney are now working to change this scenario.

Customized products

In the current financial landscape, a diverse array of lending options is available to investors, ranging from traditional banks to innovative fintech platforms. The latter includes VoltMoney, DhanLAP, AbhiLoans, Mirae Asset Financial Services, and Bajaj Finserv. All of them have varying loan-to-value ratios. The interest rates too vary, with most banks offering loans at 8-16% (with an average of 11%). VoltMoney, which has a tie-up with Bajaj Finance, lends at 9-11%, while Mirae Asset Financial Services lends at 9%.

Graphic: Mint
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Graphic: Mint

As for processing fees, banks impose digital fees of around 0.5-1% and physical fees in the range of 2,000-4,000 plus GST (goods and service tax). In contrast, VoltMoney and Mirae Asset Financial Services charge 999 plus GST. Payment options range from balloon payments (wherein the entire principal is paid at the end of the loan) to equated monthly instalments, or EMIs (regular payment of principal).

Borrowers enjoy the liberty of choosing their repayment approach. This credit line facility offers unparalleled flexibility, enabling borrowers to defer principal repayment. As the month concludes, the obligation primarily involves repayment of only the interest.

“Throughout the loan tenure of 12 months, only the interest amount is debited monthly based on the outstanding utilized amount. There is no fixed schedule for repaying the principal; borrowers can make principal repayments at any point within the one-year period. The account can be renewed for another 12 months upon maturity, with the principal amount carrying forward. When closing the loan account, the entire outstanding amount becomes due for repayment", said Krishna Kanhaiya, CEO, Mirae Asset Financial Services (India) Pvt. Ltd.

The minimum ticket size is 25,000 and the maximum 5 crore, depending on the lender. Some institutions restrict loans to their own schemes, while others encompass a broader range of options. Borrowers have the opportunity to select loans that align with their financial goals and preferences, capitalizing on a diverse array of products and features.“We’ve had use cases where people have used this in place of car loan (used and new), reinvesting in market or for IPOs, working capital for small/medium businesses, medical emergencies, etc.," said Lalit Bihani , CEO, VoltMoney.

The loan process

Pledging of MF units is a very simple and easy process, especially with fintech platforms. Investors should first set up an account on the chosen platform. A one-time verification process then confirms the user’s identity using Aadhaar and PAN credentials, adding a layer of security and compliance to the procedure.

Investors can then handpick the specific MFs against which they intend to secure a loan. The digital pledge of the selected MF units is facilitated through the robust infrastructure of RTAs like CAMS and Kfintech. Users experience a seamless verification via a one-time password (OTP), ensuring the authentication of this pledge. Through this digital lien marking, the MF units are essentially locked in favour of the lender, preventing any redemption or sale until the loan is repaid.

Once the loan agreement is drawn up, the user can electronically sign it, a process fortified by OTP verification to validate the user’s informed consent. Additionally, users confirm their designated bank account and establish an e-mandate, which serves as an automated mechanism for loan repayment.

A flexible choice between an overdraft and immediate disbursal loan empowers users to tailor the loan structure according to their financial requirements. Users often receive the loan amount on the very day they apply, a feature that sets fintech-driven MF loans apart from traditional lending methods.

Pros and Cons

“Often, one tends to sell MF holdings to fund shorter term requirements since it is intuitive and the path of least resistance. However, doing so can be detrimental to the compounding journey and there is the possibility of the investor incurring exit loads. Also, MF units that are sold at a premium attract capital gains taxes that immediately dent your net inflows", said Nirav Karkera, head of research at Fisdom.

Unlike redeeming your MF units, which could incur capital gains tax and disrupt the compounding process, a loan doesn’t trigger tax liability and allows your investments to continue growing. This approach also circumvents unfavourable market timing, sidesteps exit load charges, and enables you to retain your investment strategy and allocation. Furthermore, loans provide short-term liquidity while safeguarding your long-term investment objectives, offering a versatile solution for various financial needs.

“If these funds are part of your business balance sheet, the interest you pay on the loan can be a tax-deductible business expense," says Nitesh Buddhadev, a Mumbai-based chartered accountant and founder of Nimit Consultancy.

Financial experts say it is advisable to contemplate borrowing when markets have experienced substantial declines and asset prices are lower. Although this might not yield a larger loan, it mitigates risk and guards against losses incurred from selling units at reduced prices. Subsequent market rebounds would shield you from margin calls or collateral requests, given the potential growth in MF investments with rising asset prices. However, be prepared for the possibility of paying a margin or offering more collateral if markets and asset prices unexpectedly plummet further. This strategic approach balances the benefits and risks of borrowing against MF holdings.

“It is not a sin to withdraw money from MFs. After all, the open-ended nature of MFs allows you to do so. Hence, if one has a long-term time frame for MFs and can still make up with savings, we don’t think MF money is untouchable. Investors need to remember that no AMC or distributor will want you to withdraw money and remove the AUM that is earning them their fee. Hence, take the advice on loan against MFs with a pinch of salt," said Vidya Bala, co-founder, PrimeInvestor.in

Mint’s research shows that while loans have a starting cost of 10% (comprising 9% interest and 1% fees), historical data shows Nifty 50 generated over 10% rolling one-year returns about 54% of the time over the last 15 years. It generated returns of over 10% in 3-year rolling periods 58% of the time, underscoring the challenge of consistently outperforming loan costs through market returns. Furthermore, as markets mature and active returns or alpha begins to erode, the future outcomes become increasingly uncertain and difficult to predict.

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