Have you faced a financial emergency and had no choice but to sell off your investments to meet the unexpected costs? Most people go through this challenging scenario at some point.
However, did you know that if you have mutual funds investments, you can pledge them as collateral to borrow funds from a bank or NBFC? Before you do this, you need to understand how the interest rates of loans against mutual funds work.
A wide range of parameters decides the interest rate on a loan against MF investments. Here is a closer look at some key factors that drive the interest rates on such loans.
The bank or NBFC may have its own terms and conditions for calculating the interest rates applicable on loans availed against mutual funds. This depends on the lender’s internal policies, and borrowers have no control over it.
The type of mutual fund may also influence the loan's interest rates. Loans against debt funds, which are less volatile, may be more affordable than loans against market-linked equity mutual funds.
The repo rate is the interest rate at which the central bank lends funds to commercial banks. If the repo rate increases, the cost of borrowing also rises for all kinds of credit facilities. Thus, the interest rate on such loans against mutual funds increases if the repo rate increases.
The Marginal Cost of Funds Lending Rate (MCLR) is the lowest rate of interest that a bank can levy on its loans. It depends on the prevailing repo rate. Banks add a spread over the MCLR and charge interest on loans against MFs.
Aside from the factors outlined above, the particulars of the loan itself may influence the interest rates. These factors include aspects like the chosen repayment tenure and the loan amount.
The bottom line is that the interest rates of loans against mutual funds are generally lower than those of many other credit facilities. That said, you will still have to repay the principal and the interest completely to release the lien on your mutual funds. For this reason, ensure that you only avail of the LAMF facility if there is a non-negotiable financial emergency.
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It may be a good idea to take a loan against an MF if you want to meet your emergency financial needs without liquidating your investments or suffering the burden of high-interest rates.
The exact interest rates of loans against mutual funds vary from one lender to another. However, the interest rates are typically nominal since these are secured borrowings.
You pledge your existing mutual fund investments with a lender and borrow funds against this collateral. You cannot redeem your mutual funds until you repay the loan and the interest charged.
Mutual funds only offer returns; they do not offer any interest. The returns on debt mutual funds depend on the interest rates of the underlying debt securities, while the returns from equity funds are market-linked.
The rise in the prevailing interest rates can make all borrowing costlier. So, before you avail of the LAMF facility, check the interest rates of loans against mutual funds and the market rates.
