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Pros and Cons of Digital Loans Against Mutual Funds

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Created on
September 7, 2023

Summary

What’s Inside

Digitalisation has introduced innovative products and services, such as digital loans against mutual funds, allowing investors to access funds while keeping their investments.

What are Loans Against Mutual Funds?

  • Loans against mutual funds allow you to borrow money using your mutual fund investments as collateral.
  • You get a loan based on the value of your mutual funds, pay interest on the borrowed amount, and repay it over time.
  • It's a way to access cash while keeping your investments intact.
  • Instead of selling their mutual fund units, investors can now pledge them as collateral to obtain loans from banks and financial institutions. This process is streamlined and often conducted digitally, reducing paperwork and processing time.

While this financial instrument offers flexibility and convenience, weighing its pros and cons carefully is essential. Let’s explore in this detailed blog!

The Pros of Digital Loans Against Mutual Funds

1. Liquidity

One of the primary advantages is the ability to access liquidity without liquidating your mutual fund holdings. This is particularly beneficial if you believe in the long-term potential of your investments and do not wish to disrupt your portfolio.

2. Convenience

Digital loans against mutual funds are known for their speedy approval and disbursement processes. With minimal documentation and an online application, borrowers can access funds swiftly during emergencies or planned expenses.

3. Competitive Interest Rates

Banks and financial institutions often offer competitive interest rates on these loans, making them attractive compared to high-cost alternatives like credit card debt or personal loans.

4. Ownership Retained

When you opt for a digital loan against mutual funds, you continue to benefit from any potential capital appreciation and dividends generated by your investments. This ensures that your money continues working for you.

The Cons of Digital Loans Against Mutual Funds

1. Risk of Margin Calls

If the value of your pledged mutual fund units falls significantly, you may face a margin call. In such cases, you might be required to either repay a portion of the loan or pledge additional collateral to cover the shortfall.

2. Potential Liquidation

If you fail to meet margin calls or repay the loan as agreed, the lender has the right to liquidate your mutual fund units to recover the outstanding amount. This can result in capital losses and tax implications.

3. Limited Loan-to-Value (LTV) Ratio

Often, lending institutions offer loans up to a certain percentage of the mutual fund's Net Asset Value (NAV). The LTV ratio varies, and borrowers may not be able to access the full value of their investments.

4. Interest Costs

While interest rates on these loans can be competitive, they still represent an additional cost. Borrowers need to assess whether the returns on their mutual fund investments justify this expense.

Considerations Before Opting for a Digital Loan Against Mutual Funds

Consider the following before getting a digital loan against mutual funds:

  • Ensure the loan aligns with your financial goals and won't hinder your long-term objectives.
  • Understand the risks involved, like margin calls and a forced liquidation's impact on investments.
  • Compare loan terms, interest rates, and fees from different lenders to get the best terms.
  • Assess the impact of pledging mutual funds on portfolio diversification. Overconcentration can increase risk.
  • Develop a clear repayment strategy to meet obligations and get your mutual fund units back promptly.

In Conclusion

Digital loans against mutual funds can be a valuable financial tool, however, like any financial product, they come with their share of risks and costs. Moreover, not everyone may have mutual fund units to take a loan against. Fortunately, though, you can always opt for an instant personal loan.

Instant Personal Loans Made Easy with Fi

Fi Money provides instant loans that arrive directly in your savings account. These are pre-approved personal loans made available to select users with good credit scores. On Fi, this process is 100% paperless, and the loans are provided at competitive interest rates — where each user remains in control with complete visibility of all details. Plus, you can avoid EMI late fees by setting up automatic in-app payments. Our licensed partner bank assigns an eligible loan amount to each user (up to ₹5 lakh).

Frequently Asked Questions

1. What is a digital loan against mutual funds?

In a digital loan against mutual funds investors pledge their mutual fund units as collateral to obtain a loan from banks or financial institutions, all processed digitally.

2. How does getting a digital loan against mutual funds work?

Investors apply online, pledging their mutual fund units as collateral. After due diligence and valuation, lenders disburse the loan amount directly into the borrower's account.

3. What are the benefits of taking a digital loan against mutual funds?

Benefits include liquidity without selling assets, quick approval, competitive interest rates, and continued ownership of mutual fund returns.

4. What are the risks of using mutual funds as collateral for a digital loan?

Risks include margin calls due to falling mutual fund values, potential liquidation, limited loan-to-value ratio, and additional interest costs.

5. Are there any eligibility criteria for a digital loan using mutual funds?

Eligibility criteria typically involve a minimum mutual fund portfolio value, acceptable fund types, and compliance with lender-specific terms and conditions.

Disclaimer

Fi Money is not a bank; it offers banking services through licensed partners and investment services through epiFi Wealth Pvt. Ltd. and its partners. This post is for information only and is not professional financial advice.
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