Understanding the Terms of Loan Against Mutual Funds
With total assets under management (AUM) surpassing ₹50 lakh crores in India, mutual funds have become a pivotal financial asset for investors seeking to access credit.
As seen in aggressive marketing campaigns by leading financial institutions like SBI, prominently featuring endorsements by icons like Dhoni, it's clear that Loans Against Mutual Funds (LAMF) are being positioned as a key financial solution. This growing trend underscores the financial sector's commitment to leveraging popular investment avenues to offer added liquidity options to investors.
Given this surge in interest and availability, understanding the terms associated with LAMF becomes essential. This blog aims to equip you with the knowledge to navigate these options, helping you make informed decisions that align with your financial strategies and goals.
Also Read: Myths and Facts About Loan Against Mutual Fund
Factor # 1: Interest Rates
The interest rate is the cost you pay on the borrowed money, expressed as a percentage of the loan.
Knowing the interest rate is crucial as it affects the overall cost of the loan and your monthly repayment amounts. A lower interest rate means lower costs over the life of the loan.
Interest rates on LAMF are generally between 10% and 12% annually but can vary based on market conditions, the lender, and your financial profile.
Factor # 2: Loan-to-Value Ratio (LTV)
The Loan-to-Value Ratio indicates the percentage of your mutual fund's value that you can borrow against. It determines the maximum loan amount relative to the value of the mutual funds you have invested in.
Understanding the LTV ratio helps you assess how much you can borrow and ensures that you do not over-leverage your investments. It also influences the risk level of the loan from the lender's perspective.
Typical LTV ratios for LAMF range from 50% to 70%. This means if your mutual funds are worth Rs. 10 lakhs, you can potentially secure a loan amount between Rs. 5 lakhs and Rs. 7 lakhs.
Explore: Finsire’s LTV Calculation APIs
Factor # 3: Repayment Terms
Repayment terms define the schedule and methods by which you will repay the loan, including the tenure and the frequency of payments.
Clarity on repayment terms helps you plan your finances and ensures that the loan repayment aligns with your cash flow, preventing financial strain.
Loan tenures for LAMF can range from 6 months to 5 years, giving you the flexibility to choose based on your financial situation.
Factor # 4: Margin Call
A margin call occurs when the value of the pledged mutual funds drops and falls below a specified percentage of the loan value, necessitating additional payments or collateral to maintain the loan.
Knowing about margin calls is essential for managing the risks associated with borrowing against market-linked securities like mutual funds, which can fluctuate in value.
Margin calls typically trigger if the mutual fund value falls below 70%-80% of the LTV, though this threshold can vary by lender and agreement.
Factor # 5: Foreclosure and Prepayment
Foreclosure refers to the full repayment of the loan before the end of its term, while prepayment specifically involves paying more than the scheduled loan installment at any given time without clearing the full loan.
Understanding these options can significantly reduce the total interest paid and provide financial flexibility, especially if you come into unexpected funds.
While many lenders offer nil charges on prepayment and foreclosure, some may charge up to 2-3% depending on the terms agreed upon at the outset of the loan.
Factor # 6: Processing Fees
Processing fees are charges levied by the lender to cover the costs associated with the processing of the loan application, which includes document verification and the assessment of your mutual fund holdings.
Being aware of processing fees is important because these fees can add to the overall cost of obtaining the loan. It helps in comparing different lenders based on not only interest rates but also on how much they charge upfront.
Processing fees can range from 0.5% to 2% of the loan amount, depending on the lender. Sometimes, these fees are waived during special promotional periods.
Factor # 7: Tenure
Tenure refers to the duration over which the loan will be repaid. It affects both the size of the monthly payments and the total amount of interest paid over the life of the loan.
Choosing the right tenure can help manage your monthly budget effectively. A longer tenure reduces monthly payments but increases the total interest, whereas a shorter tenure increases monthly payments but decreases total interest costs.
Loan tenures for LAMF typically range from 6 months to 5 years, allowing you the flexibility to choose a period that best matches your financial plan.
Factor # 8: Default Consequences
Defaulting on a loan means failing to meet the legal obligations of the loan agreement, typically by not making the required payments. It can lead to the lender seizing the collateral, which in this case are the mutual fund units.
Understanding the consequences of default is crucial as it impacts your credit score and future borrowing capabilities. It also puts your mutual fund investments at risk of being sold off to cover the loan.
Default rates and related penalties can vary, but typically, after a grace period of 30-60 days post-missed payment, lenders may initiate recovery procedures.
Factor # 9: Automatic Renewal
Some LAMF agreements include an automatic renewal clause, which means the loan is automatically renewed at the end of its tenure unless the borrower decides to end it.
Knowing whether your loan has an automatic renewal clause is important for financial planning. Without proper management, you might find yourself in a cycle of perpetual debt.
Renewal policies vary by lender but generally involve reassessing the value of the mutual fund assets and possibly adjusting the loan terms.
Factor # 10: Rights to Dividends or Gains
Even though your mutual funds are pledged as collateral, you retain ownership of the investments and therefore any rights to dividends or capital gains distributed by the fund.
It’s important to know that you continue to benefit from any dividends or gains, as these can be used to offset the cost of borrowing or reinvested to enhance your financial position.
Dividend yields on mutual funds can vary widely but understanding the average returns on your investments can help you calculate potential gains during the loan period.
Factor # 11: Credit Score Impact
Your credit score reflects your creditworthiness based on past and current credit behavior. Taking out a loan against mutual funds can impact your credit score, depending on how diligently you manage the loan repayments.
Maintaining a healthy credit score is crucial for future financial activities, such as securing loans with favourable terms. Timely repayments can improve your score, while defaults can significantly damage it.
Regularly paying off your loan on time can positively influence your credit score. Missing even a single payment can lower your score by 50 to 100 points depending on the credit bureau’s scoring model.
Factor # 12: Loan Disbursement Time
This refers to the time it takes for the loan amount to be credited to your account after the loan application has been approved.
If you are relying on the loan for urgent financial needs, knowing the disbursement time will help you plan accordingly.
Loan disbursement for LAMF can vary from a few hours to a few days after approval, largely depending on the lender’s processes and the efficiency of the platforms used (like online banking).
Factor # 13: Exit Strategy
An exit strategy in the context of LAMF refers to your plan for fully repaying the loan and releasing your mutual funds from the pledge.
Having a clear exit strategy is vital to ensure you can free up your investments at the desired time without financial strain.
Reviewing the terms for early repayment and aligning them with your financial goals (e.g., planning for when mutual funds are expected to peak in performance) can help optimize your financial strategy.
Factor # 14: Legal and Contractual Obligations
These are the terms and conditions outlined in the loan agreement that legally bind you and the lender.
Being well-informed about your legal and contractual obligations helps you adhere to the terms of the loan and avoid potential legal issues.
Always review any penalty clauses or fees for non-compliance that could impact you financially; for example, some contracts may include administrative fees for handling specific requests or legal fees in case of disputes.
Finsire Can Help
Loans against mutual funds are a fantastic tool for managing your finances without disrupting your long-term investment goals. They offer flexibility and maintain your investments’ growth trajectory, all while giving you access to needed funds. Whether it's for handling emergencies, financing education, or other substantial expenses, consider this option to keep your financial plan on track.
Finsire's API provides substantial benefits to borrowers engaging in Loans Against Mutual Funds (LAMF) by enhancing transparency and control over their financial engagements. It offers detailed insights into active loans, the specifics of mutual fund units pledged as collateral, and comprehensive payment histories. This access allows borrowers to efficiently track their financial commitments and repayment progress. The clarity and oversight provided by Finsire's API help borrowers maintain financial discipline and make informed decisions regarding their loan management, promoting a transparent and accountable borrowing experience.
For lenders, Finsire’s API delivers an array of powerful tools that streamline the management of loan portfolios. The consolidated dashboard feature aggregates all loans into a single view, showing detailed loan information, including the mutual funds pledged, loan amounts, interest rates, and terms. Additionally, the ability to schedule and monitor pending payments enhances lenders' capacity to manage their cash flow and mitigate financial risks effectively. This comprehensive suite of features ensures that lenders can assess risks accurately, manage loans efficiently, and maintain robust financial health across their operations.
Finsire’s Suite of APIs for Loan Against Mutual Fund Implementation for Lenders: CAMS | KFintech | MFCentral
