Pledging Mutual Fund Units: A Quick Guide
3 October, 2024
Synopsis:
Mutual funds can be pledged as collateral for loans, allowing access to funds without liquidating investments.
The loan amount typically ranges from 50-80% of the market value of the investment, depending on whether it's an equity or a debt fund.
Pledging mutual funds often results in lower interest rates than unsecured loans.
The pledged units cannot be sold or redeemed. However, investors continue to get dividends and other benefits on pledged units.
Pledging Mutual Fund Units: A Quick Guide
There are times when you need money urgently, however, you wish you could raise the money without liquidating your investments. Mutual funds provide the window of opportunity that you are looking for - you can use your mutual funds as collateral for a loan. Let's understand how mutual funds can be pledged and what it means to you.
What Does Pledging of Mutual Funds Mean?
Pledging mutual funds is like using your investment as security for a loan. Instead of selling your units, you can borrow money against them. It's similar to how gold or property are used as collateral, the only difference being that in this case, your mutual fund units are the collateral.
Can Mutual Funds be Pledged?
The answer is Yes! Many banks and financial institutions in India allow you to pledge mutual funds. This means you can get a loan without having to sell your investments. It's a way to access cash while keeping your long-term investment plans intact.
How to Pledge Mutual Funds: A Step-by-Step Guide
Check Eligibility: Ensure your mutual fund scheme is on the lender's approved list.
Apply for the Loan: Approach your chosen bank or financial institution with your request.
Submit Documents: You'll need to provide:
- Filled application form
- Recent passport-size photo
- Details of the mutual funds you want to pledge
- ID proof (Aadhaar, passport, etc.)
- Address proof
- Income documents (salary slips, tax returns)
4. Lien Marking: The lender will ask the mutual fund company to mark a lien on your units.
5.Verification: The mutual fund registrar will verify the details and mark the lien.
6.Loan Approval: The lender will approve and disburse your loan once the lien is marked.
Remember, while the units are lien-marked, you can't sell or redeem them. However, you'll keep receiving dividends or other benefits on pledged units, if any.
How Much Can You Borrow?
The loan amount depends on the type of mutual fund:
For equity funds: Usually, up to 50% of the market value of your investments
For debt funds: Up to 80% of the value
These percentages can from lender to lender, so it's worth shopping around.
Why Choose a Loan Against Mutual Funds?
Lower Interest Rates: Compared to personal loans, loans against mutual funds often have lower interest rates. While personal loans might charge between 12% and 20% interest, loans against mutual funds typically range from 8% to 12%.
Quick and Easy: Getting approved for a loan against mutual funds is usually faster than unsecured loans.
Flexible Repayment: Many lenders offer flexible repayment terms, making it easier to manage your loan.
Keep Your Investments: You don't have to sell your mutual funds, allowing your investments to grow.
No Impact on Credit Score: Unlike personal loans, your credit score usually isn't a major factor in approval.
Let's assume that the market value of Priya’s equity mutual fund holdings is ₹5 lakh. She needs ₹2 lakh for her sister's wedding. Instead of selling her investments, she pledges her mutual fund units. The bank offers her a loan of ₹2 lakhs (40% of her units’ market value) at 10% interest for 2 years. Thus, Priya gets the money she needs, and her long-term investment plans remain intact too.
Things to Keep in Mind
Interest Costs: While rates are lower than personal loans, you still pay interest. Make sure the cost makes sense for your situation.
Market Fluctuations: If the value of your pledged funds drops significantly, the lender might ask you to pledge more units or repay part of the loan.
Redemption Restrictions: You can't sell the pledged units until you repay the loan.
Choose Wisely: Not all mutual funds can be pledged. Check with your lender for the approved list.
Pledging mutual funds can be a smart way to access funds without disrupting your investment strategy. It offers lower interest rates than many unsecured loans and doesn't require you to liquidate your investments. However, like any financial decision, weighing the pros and cons is important based on your situation. Consider your repayment capacity and the potential impact on your long-term financial objectives before pledging your mutual funds.
Download the HDFC Bank SmartWealth App to explore mutual fund schemes that align with your investment objective and investment appetite.
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