When you need financial support, choosing the right type of loan is crucial. Two options that frequently come up are a loan on mutual funds and a personal loan. Both provide access to funds, but their features, conditions, and benefits vary significantly. If you hold mutual funds and are considering borrowing against them, understanding the mechanics, costs, and terms of a loan on mutual funds compared to a personal loan will help you decide what fits your needs best. This blog will clarify the differences and highlight important aspects like the interest rate on loan against mutual funds, helping you make a well-informed choice.
Understanding what a loan on mutual funds entails
A loan on mutual funds is a secured loan where your existing mutual fund units act as collateral. Essentially, instead of selling your investments during a cash crunch, you can pledge these units and get a loan amount against their value. This type of loan is designed specifically for investors who want to keep their mutual fund investments intact while accessing liquidity.
How does it work
– You pledge your mutual fund units to a lending institution.
– The lender advances you a loan up to a certain percentage of the units’ market value, commonly around 70-85%.
– The loan tenure is generally flexible, often ranging from a few months to a few years.
– Once the loan repayment is done, your mutual fund units are released back to your demat or mutual fund account.
This method allows you to maintain your investment portfolio while solving short-term liquidity needs.
Interest rate on loan against mutual funds
Loan on mutual funds usually comes with a lower interest rate compared to unsecured loans such as personal loans. Because your mutual funds act as collateral, the risk for lenders is reduced, which results in more favourable rates. These interest rates can vary depending on the lender and the mutual fund’s performance but typically range between 9% to 14% per annum in the Indian market.
What is a personal loan
A personal loan, by contrast, is an unsecured loan. It is offered purely based on your creditworthiness without any collateral. This makes it easier to access funds quickly, but usually at a higher interest rate and with stricter eligibility criteria.
Features of personal loan
– No collateral is required.
– Loan amount depends on your income, credit score, and repayment capacity.
– The tenure is usually short to medium term, up to 5 years.
– Interest rates tend to be higher because of the increased risk faced by lenders.
Unlike the loan against mutual funds, a personal loan is more suited for individuals without existing investments or for who want quick access to cash without pledging any assets.
Comparing loan on mutual funds and personal loan
Eligibility criteria
Loan on mutual funds requires you to have mutual fund investments. The quality and liquidity of these investments influence your eligibility. On the other hand, personal loans focus more on your credit score, income, and existing financial obligations.
Processing time
Getting a loan on mutual funds can take slightly longer due to the pledge process where the lender verifies your mutual fund holdings. In contrast, personal loans often have faster approval, sometimes within 24 to 48 hours, thanks to digital lending platforms.
Loan amount and tenure
Loans on mutual funds usually allow borrowing up to 70-85% of your investment’s market value. Personal loans’ amounts depend mainly on your income and credit capacity but are not tied to any asset. Tenure flexibility varies but personal loans typically range from 1 to 5 years.
Cost of borrowing
With a loan on mutual funds, interest rates are lower because your risk is secured by the pledged units. Personal loans have higher interest rates to compensate for being unsecured. Loan on mutual funds might also have processing fees but these are usually reasonable compared to personal loans.
Impact on investment
When you take a loan on mutual funds, your investment remains with you. You continue to benefit from dividends or capital appreciation unless you default. For personal loans, your investments remain untouched as collateral is not required.
Repayment and risk
If you fail to repay a loan on mutual funds, the lender can sell your pledged units to recover dues. This makes it a less risky option for lenders but involves some risk for you if market values fall. Personal loans carry the risk of penalties or legal actions but do not directly impact your investments.
When to prefer a loan on mutual funds
– You want to keep your mutual fund investments intact.
– You can get funds at a lower interest rate.
– You need flexible repayment tenure.
– You have significant mutual fund holdings that can be pledged.
– You are looking to avoid credit checks or lengthy approval processes dependent on credit history.
When to prefer a personal loan
– You do not own mutual fund investments or sufficient assets to pledge.
– You want quick access to money without pledging collateral.
– The required loan amount is beyond the permissible limit against your investments.
– You prefer not to risk your investments against loan default.
– Your credit profile is good enough to secure reasonable personal loan terms.
Some key considerations before applying for either loan option
– Loan to value ratio: For loans on mutual funds, understand how much you can borrow relative to your investment. Lenders typically allow 70-85%, so the market volatility affects borrowing power.
– Interest rate transparency: Ensure clarity about how the interest rate on loan against mutual funds is calculated and whether it is fixed or variable.
– Fees and charges: Look out for processing fees, foreclosure charges, and penalties applicable for missed payments.
– Market risk: In a loan against mutual funds, declining unit prices can increase the risk of margin calls or demand for additional collateral.
– Repayment flexibility: Some lenders provide options to pay interest only during the tenure or convert the loan into EMIs. Check what suits your cash flow.
Real-life example
Consider Sarah, an investor with Rs. 50,000 in mutual fund units. She wants Rs. 30,000 for a home renovation. A loan on mutual funds could allow her to borrow up to Rs. 42,500 (85% of fund value). She chooses this option at an interest rate of 11%, lower than the 18% a personal loan offered her.
Sarah continues to hold her investments which appreciate over time, and she repays the loan in 2 years without liquidating assets. The lower interest cost and asset retention made the loan on mutual funds better suited for her scenario.
Conclusion
Choosing between a loan on mutual funds and a personal loan depends on your financial situation and priorities. A loan on mutual funds offers the advantage of secured borrowing at a lower interest rate on loan against mutual funds and allows you to preserve your investments. Meanwhile, personal loans provide quick access to funds without collateral but come with higher costs.
By understanding these differences, you can make better choices aligned with your borrowing needs. If you own mutual fund units and seek affordable financing options, a loan on mutual funds is worth considering. Conversely, if you need speed and simplicity, personal loans remain a strong option. Being clear on your financial goals will guide you to the best fit.
