For most people born prior to the digital boom, hearing the word ‘loan’ often paints negative imagery of having to do rounds at the bank, convincing people to be cosigners, and pledging properties as collaterals. All these things sound like a recipe that burns bridges and financial nets.
That said, a question that arises naturally is, what has happened after the digital boom? The answer is a significant change in perspective when considering loans.
As new ideas have been cultivated with the aid of technology, the negative connotation associated with loans has subdued. One such idea is to use investment and mutual funds as collateral when borrowing funds.
For those reading about it for the first time, the concept may appear non-traditional or even too good to be true. Let’s explore this concept in depth to gain clarity.
What is the concept of loans against mutual funds and investment products?
Similar to how assets, like real estate or gold, are used as collateral for different types of loans, investments can also function as collateral. Borrowers can pledge their mutual fund investments while retaining full ownership of the investment as long as the loan terms allow. In other words, the requirement of funds can be fulfilled without compromising on the usual investment appreciation as long as the ownership is retained.
Further, a few more attributes distinguish the concept of getting a loan against mutual funds from traditional lending and borrowing procedures.
1. Online process: The domino effect of the increased popularity of this concept has led to the development of apps that specialize in investment-based lending. Unlike traditional borrowing experiences comprising physical commute to banks and submission of the hard copy of documents, apps complete everything from the application to approval entirely online. Most apps partner with SEBI-approved institutions to verify the ownership of mutual fund investments and provide investors mutual fund to upload their KYC documents from within the app.
2. Borrower-friendly repayment terms: Most, if not all, lenders that provide loans against mutual funds only require borrowers to pay the interest and not the EMI. The principal can be paid at any time during the tenure of the loan. This results in significant benefits for borrowers concerned with their cash flow and budgeting goals. By only paying interest, borrowers can maintain lower monthly payments, freeing up financial bandwidth for other priorities. The ability to repay principal at any time gives borrowers control over their debt management strategy. They can choose to chip away at the principal when extra funds are available or wait until their investments have grown further before selling units to repay the loan.
3. No credit checks: Most lenders, whether they operate online or offline, heavily rely on credit checks before approving loans. This is not the case concerning loans against mutual funds. Since collateral is already pledged, the importance of credit scores is often on the backseat. This ensures equal borrowing opportunities for investors with weaker credit scores or no credit history.
However, amidst all this, there are a few things that investors should consider before pledging their investments:
1. Does the portfolio comprise the eligible mutual funds?
Not all types of mutual funds may be eligible for pledging as collateral. It’s always advisable for borrowers to check with the concerned financial institution prior to deciding whether this borrowing route would be the best option for their financial needs. Some borrowers may even consider rebalancing their portfolio by adding some eligible and excellent mutual funds to invest in before filling out the loan application.
2. Do the investments provide complete coverage of the financial need?
The amount that can be borrowed often depends on the value of the mutual fund investments in an investor’s portfolio. A loan against mutual fund calculator can be used to determine if the investments are enough to borrow the required amount. It’s important to note that the upper and lower limits set by lenders can vary; thus, the choice of lender should also be made keeping this in mind.
To conclude, pledging mutual funds for loans is a remarkable concept that increases financial accessibility for those with significant needs but a subpar credit history. The retention of investment ownership, lower interest, and tax savings are among the biggest benefits of pledging mutual funds.