“MF units are transferable with transparent valuation, making them ideal instruments to raise money. One could continue to hold MF units to participate in long-term growth and avail tax benefits, and yet generate liquidity to meet short term fund requirements,” said Sandeep Bagla, Chief Executive Officer at Trust Mutual Funds.
Borrowing against units should generally be used for meeting short-term fund requirements only and not for creating long-term leverage in the portfolio, Bagla recommended. One must ensure that the money raised is for a short tenure and repaid in time as the interest rates on borrowings could be relatively high, he added.
Typically, bonds have low volatility versus the equities, and hence one can borrow more by pledging debt mutual fund units, stressed Bagla while speaking to ETMarkets.
A lender would apply a haircut on the market value of the units and provide a loan, less than the market value in case of market corrections, the Trust Mutual Funds expert said.
However, Gurmeet Singh Chawla, Director, mastertrust, has a piece of advice for investors willing to pledge their equity of debt mutual funds to avail loans. He said pledging one’s mutual fund investment as collateral for a short-term loan can be deemed a prudent alternative. However, it does not come without risks.
It can facilitate immediate liquidity but it was imperative to meticulously examine the terms, interest rates, and potential complications, Chawla said. “Engaging the expertise of a financial advisor can provide a thorough analysis of the advantages and disadvantages, enabling alignment with your overall financial objectives and risk tolerance,” he added.
The act of pledging exposes the mutual funds to the potential volatilities of the market, thus compromising their valuation, Chawla pointed out. Moreover, the failure to repay the loan could result in penalties or the complete loss of investment, he added.
He also opined that pledging mutual funds for loans can come at a higher cost as short-term interest rates for these transactions are mostly on the higher side.
ETMarkets also spoke to Volt Money, a company which provides loans against mutual funds, to understand things in perspective.
“Banks & NBFCs have a very tedious process for offering loans against securities. It’s an offline process that can take 7 to 28 days. Whereas, our customers have urgent cash requirements and require a seamless experience. We’ve built deep integrations with top-rated NBFCs to offer low interest rates and flexible repayment terms and a 100% digital experience,” Lalit Bihani, Volt Money Co-founder and Chief Executive Officer told ET Markets. .
The company claims to be offering loans at competitive interest rates as offered by top banks and NBFCs. It has tied-up with NBFCs and adheres to regulations which apply to them, Bihani said.
The loan eligibility is based on the current value of mutual fund investments and banks or fintech companies consider factors, including historical performances of the mutual fund schemes and market fluctuation risks to determine the credit limit.
“We provide up to 90% of the value for debt mutual funds, and up to 50% of the value for equity mutual funds. Ineligible mutual funds are not included for calculating credit limits. Reasons for ineligibility include locked units and funds that are not approved for pledging by lenders,” Bihani said.
If the value of the units in specific schemes increases, customers can request for an increase in the credit limit and Volt Money does not automatically increase the limit. If value drops below loan to value percentage, customers can either make payment for the shortfall amount, pledge more securities or request for selling of securities, the Co-founder & CEO said.
Volt Monet has disbursed loans worth over Rs 30 crore with average ticket size of Rs 6 lakh. The minimum loan amount that is processed by the company is Rs 25,000 while the maximum amount is Rs 2 crore.
Dos and Don’ts
1) Before applying for a loan, thoroughly assess your future cash flows, and overall financial standing and decide if it is required and aligns with your goals, Chawla of mastertrust said.
2) Make sure you fully understand the conditions, interest rates and payback timeline before signing any agreement or doing any paperwork, Chawla said.
3) It is necessary to maintain a buffer in your mutual fund investment to mitigate the impact of market fluctuations, Chawla said.
4) Don’t borrow more money than you truly need because doing so might result in extra interest payments.
5) Remember to have a repayment strategy in place to guarantee on-time loan payback.
6) Be mindful of the risk that might arise, including fines or losing your investment if you fail to repay the loan.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)