Home >Money >Personal Finance >You can use your mutual fund units to generate liquidity
The MF units can be used as a collateral for loans just like gold, share and other assets.  (Photo: iStockphoto)
The MF units can be used as a collateral for loans just like gold, share and other assets. (Photo: iStockphoto)

You can use your mutual fund units to generate liquidity

  • But keep in mind that a loan against mutual fund units comes at a cost. Other than interest cost, loan processing fee and maintenance charge will be levied by the lender

The mutual fund units you hold can be used as a collateral for a loan just like gold, shares and other assets. Banks, financial institutions and non-banking financial (NBFCs) companies accept mutual fund units as a collateral for loans. The lending institution, typically, has a list of schemes they are willing to accept as security for loans.

The extent of loan that you can avail will depend upon the net asset value (NAV) of the scheme and the haircut applied by the lender. For example, the lender may specify that the loan against mutual funds will be limited to 50% of the NAV of the mutual fund units. The limit is, typically, higher for debt fund units since they are less volatile.

The documentation required to avail the loan is prescribed by the lender and this includes providing a loan application and supporting documents to establish the proof of identity, address and signature of the applicant. Along with this, the borrower has to mark a lien on the units pledged for the loan. This is done through an application, providing the details of the pledge, to the registrar and transfer (R&T) agents. The information to be provided includes details of the lender in whose favour the lien has to be marked, the folio number, scheme details and the number of units on which the lien has to be marked.

In the period that lien is marked on the units, it cannot be redeemed or transferred by the unit-holder or transmitted according to the directions of the unit-holder in the event of their demise. The dividends, if any, on the units are paid to the unit-holder even during the period of the lien. If the borrower fails to meet their obligations, the lender may invoke the lien and seek for redemption or transfer of the units in their favour and the same has to be executed by the mutual fund. The lien on the units will be lifted only when the R&T agent receives directions in writing from the lender to do the same. The marking of lien on units and its removal will also appear in the statement of accounts.

The loan against mutual fund units come at a cost to the borrower. There is an interest cost that has to be borne and the lender will also charge a loan processing fee and an annual maintenance charge as a percentage of the loan availed. The level of interest on this category of loans is, typically, higher than loans against gold. There is, typically, no prescription on how the loan amount will be used.

In the event of a need for funds, the unit-holder has the option to redeem the units or to borrow against them but the latter comes at a cost. The right option would depend upon the type of mutual fund units and their quality. “A loan against units is a good way to generate liquidity in an otherwise illiquid investment like a fund with a lock-in or a closed-end fund," said Santosh Joseph, CEO and founder of Germinate Wealth Solutions LLP. “For the retail investor if the asset is a long-term investment of good quality, then a loan against it which you should pay off as soon as possible is a better option than selling and being unable to build it back later. On the other hand, your portfolio will benefit if you choose to sell an investment and use the money to meet the need and redeploy into better investments," he added.

Joseph also warned against borrowing against investments to leverage other opportunities. This may harm the long-term goals for which the investments were earmarked and not worth the risk, he said.

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