Over the past few years in the realm of personal finance, loans against investments have risen in popularity, as loans against investments allow individuals to gain access to the funds tied to an asset without having to liquidate the asset in order to access the funds. Borrowing against investments in funds and securities is one of the most flexible options for individuals who wish to access an investment for quick capital. It’s a financial product that allows the individual to access funds while the investment portfolio still retains ownership of the investments, even having access to the cash for the emergencies, business expansion, or personal needs.
This article examines the loans against securities and mutual funds.
What are Loans Against Securities and Mutual Funds?
Loans against the investments or securities are loans against investments where the borrower pledges their financial assets, which can include shares, stocks, bonds, or mutual fund units. The loans against securities is a form of investing is a secured loans where the lender is is able to receive a percentage against the market worth of those investments. It is the most liquid form of an investment to gain access to. This type of loans is ideal to people who are are investors.
A loan against mutual funds operates on the same principle, where the lender extends a loan based on the mutual funds unit you own. However, this option is often only valid for open-ended mutual funds, as they are easier to liquidate.
How works?
The process to obtain a loan against investments is quite simple. Here is how it works:
- Eligibility: The borrower has to possess an investment portfolio that includes some securites or mutual funds to act as collateral. The lender will review the collateral types in the investment portfolio and their respective valuations.
- Loan to Value (LTV) Ratio: The loan amount is decided based on the LTV ratio. This is the percentage of the collateral that the lender is willing to provide a loan against. For example, assuming you possess some securites of worth ₹10 lakhs and the lender has an LTV of 50%, then you are likely to get a loan of ₹5 lakhs.
- Interest Rates: Loans against investments will usually have lower interest rates compared to the interest rates on personal goans, due to the fact that the loan is secured. The exact interest rate is, however, dependent on the lender, the collateral of the investment, and the LTV ratio.
- Repayment Terms: Just like other loans, the repayment terms will depend on the lender and the type of loan. Usually, the flexibility of the borrower involves repayment in segments or in one single installment.
- Risk: If the borrower defaults on the loan, the lender is entitled to liquidate the pledged securities or mutual funds in settlement of the debt. Hence, it’s necessary to assess your capacity to repay the loan.
Benefits of Loans Against Securities and Mutual Funds
- Liquidity Without Selling Investments: One of the main advantages of loans against securities and mutual funds is that you don’t have to liquidate your investments to obtain cash. This is beneficial in scenarios within the market where you might not want to sell.
- Lower Interest Rates: Interest rates are, on average, lower than loans that are left unsecured such as personal loans or credit cards. Because the loan is secured against your assets, It makes it a more affordable option for solutions that are needed to urgent financial crises.
- Quick Access to Funds: Usually, there is a high rate of processing of these loans. There is minimal documentation required, as compared to unsecured loans, and the faster the approval times are.
- Versatile Purpose of Loan: The money loaned can be used as you wish, whether it is to fund your child’s education, do a home renovation, or help expand your business. There is no restriction as to how you can use the money as per the lender.
- No Credit Score Check: It is also easier to get such loans for people with lower credit scores, as the lender may not check your credit score with as much scrutiny, as the loan is secured against your investment.
Downsides of Loans Against Securities and Mutual Funds
- Market Volatility: The market value of your pledged securities or mutual funds may not be stable. If the market value of your mutual funds and securities drop greatly, the lender can ask you to top-up the loan by either pledging additional assets or paying for a certain amount of the loan.
- Risk of Default: There is a chance you may not be able to pay this loan, and as with any secured loan, this may result in the sale of your pledged assets. This can result in a loss for you, depending on the market conditions of the assets at that time.
- Limited Loan Amounts: The loan amount is usually limited by the LTV ratio, meaning that you may not be able to utilize the complete value of your investments.4. Hidden Fees: Potential lenders may have lower interest rates, but they may also have processing fees, documentation fees, or penalties for paying the loan off early. Before moving forward, we have to understand the full details of what the loan will cost you.
Loans Against Securities vs Loans Against Mutual Funds
Though loans against securities and loans against mutual funds have a lot in common, there are a few specific differences, as seen in the table below:
| Parameter | Loans Against Securities | Loans Against Mutual Funds |
|---|---|---|
| Collateral | Stocks, bonds, or equity shares | Mutual funds that are open-ended |
| Loan Value | Depends on the LTV (Loan-to-Value) ratio | Depends on the NAV (Net Asset Value) of the mutual funds |
| Liquidity | Depends on the prevailing market conditions | More liquid in general |
| Risk | Market risks | NAV fluctuations of mutual funds |
| Rate of Interest | Usually lower | Usually lower |
| Eligibility | Depends on the type of securities | Depends on the type of mutual funds held |
| Tenure of Loan | Usually flexible | Usually flexible |
Choosing the ideal loan depends on your personal financial objectives as well as the type of investments you have. Consider the following:
- Analyze Your Investment Portfolio: Loans against securities may provide greater flexibility and loan amounts if you have a considerable amount invested in stocks or bonds.
- What Kind of Mutual Fund Do You Have? If you possess open-ended mutual funds, this option should be most convenient for you. If you hold closed-ended funds or have other optionalities, a loan against securities may become a better choice.
- What’s the Current Market? If you happen to be in a risky market, consider putting off the pledging of investments, as a market shift is always a possibility and would shift the value of your collateral.
When should you consider investing against your assets?
This type of loan works best for people with a rather diversified array of investments and an immediate need for cash. This is enhanced for persons who:
- Need Cash as Fast as Possible: Loan payout for securities and mutual funds is considerably faster than loan payouts for more traditional forms.
- Do Not Want to Liquidate Their Investments: If you are in the belief that your investments are of long-term value and do not wish to dispose of them, especially when the market is bearish.
- Want Lower Interest Rates: These loans are more often than not secured, and as such, supply a lower interest value than loans that are not secured.
