Loans Against Mutual Funds: Is It Better Than A Personal Loan?

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Loans Against Mutual Funds: Is It Better Than A Personal Loan?

Whenever you are cash-strapped, you tend to either go for a personal loan or a loan against mutual funds. Both are beneficial and have their own share of advantages and disadvantages. Making the correct financial decision could prove to be a boon or a bane in the long run.

Requirement of Instant Money

Let us consider you require money for some reason. This reason could be anything like a sudden hospital expense, home renovation or any other expense that was not in your plan. You exactly know how exasperating it is to arrange money in such situations. The choices you make in such scenarios could impact you in the longer run.

Confusion to Decide

The 2 options that you have in mind are a personal loan and a loan against a mutual fund. You are well aware of the hurdles and problems you face when you go for a personal loan. But at the same time, you are in the dark about the troubles you might face when you opt to dip into your mutual fund investments.

Personal Loan

A personal loan is an unsecured credit and does not require any collateral or pledge. It is fast and easy but attracts a higher rate of interest. An average interest rate in India for this loan product varies from 10.75% to 21% per annum depending upon your credit score and history.

Loan Against Mutual Funds

Whereas, a loan against mutual funds is given on the security of the investments. It is a secured credit and requires you to pledge your mutual fund portfolio as collateral for the loan. The interest rate is generally lower and falls between 9% to 13% per annum. But you must have an adequate portfolio of mutual funds to apply for a loan against it. The amount you can withdraw is also not very high and is restricted to a % of your total investments.

Now, to simplify the above 2 options, we will study the case below.

Case Study: Raj’s Dilemma

Raj, 35 years old IT consultant encountered a sudden medical emergency in his family and needs Rs. 5 lakhs to treat it. He has 2 options in his mind, either to apply for a personal loan or a loan against mutual funds.

Personal Loan for Raj:

His 1st choice was to apply for a personal loan. Raj has a credit score of 750 and approached his own bank which offered him a personal loan at an interest rate of 14% per annum. The loan tenure would be of 3 years and the EMI that Raj would pay comes around to Rs. 17,132 approx.

Loan Against Mutual Funds for Raj:

His 2nd choice was to get a loan against his mutual fund investments. He invested Rs. 10 lakhs in different mutual fund schemes over the past years. His bank sanctioned the loan at 10% of interest per annum and gave him the option to borrow as much as 50% of the value of his total investment. Thus, in this case, the loan amount would be 50% of 10 lakhs which comes to Rs. 5 lakhs.

Evaluating the Options

Raj compared both options based on several key factors:

Interest Rates:

  • Personal Loan: 14% per annum
  • Loan Against Mutual Funds: 10% per annum
Clearly, the loan against mutual funds had a lower interest rate, translating to lower overall interest payments.

EMI and Repayment:

  • Personal Loan: Rs. 17,132 per month for three years
  • Loan Against Mutual Funds: Rs. 16,129 per month for three years (assuming he borrows the same amount with similar terms)
The EMI for the loan against mutual funds was slightly lower, easing his monthly financial burden.

Collateral:

  • Personal Loan: No collateral required
  • Loan Against Mutual Funds: Mutual funds pledged as collateral
Raj had to consider the risk of pledging his mutual funds. If he defaulted, the bank could liquidate his investments.

Processing Time:

  • Personal Loan: Quick processing, with funds typically disbursed within a few days.
  • Loan Against Mutual Funds: Slightly longer processing time, depending on the bank’s procedures and the valuation of mutual funds.

Impact on Investments:

  • Personal Loan: No impact on existing investments.
  • Loan Against Mutual Funds: Investments remain intact, but their value is pledged.
Raj's mutual funds would continue to earn returns, which is an advantage over liquidating them.

After careful consideration, Raj decided to go with the loan against mutual funds. The lower interest rate and the ability to keep his investments intact were the deciding factors. He felt confident that his stable job would allow him to manage the EMIs without risking his investments.

Conclusion

When faced with the need for quick funds, both personal loans and loans against mutual funds have their unique advantages and disadvantages. Personal loans offer convenience and require no collateral but come with higher interest rates. Loans against mutual funds provide a cost-effective alternative but require sufficient investments and involve pledging your assets.

By analyzing factors such as interest rates, EMI amounts, collateral requirements, and processing times, you can make an informed decision that aligns with your financial situation. Raj's case study exemplifies the importance of evaluating all aspects before choosing the right financial solution.

In conclusion, whether you opt for a personal loan or a loan against mutual funds, the key is to understand your financial needs and capabilities. Making an informed choice can help you navigate financial challenges effectively while safeguarding your long-term financial health.


Location: India

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