Understanding Loan Against Mutual Funds: Key Features You Should Know
A Loan Against Mutual Funds, LAMF, is a way of utilizing existing mutual fund investments as collateral to meet personal or short-term financial needs. Just like personal loans, LAMF does not impose restrictions on the use of funds, and thus, becomes a great option for people who may not qualify for unsecured loans. Here are five important features of LAMF that borrowers should know before applying.
1. Loan-to-Value (LTV) Ratios Are Different
The loan-to-value (LTV) ratio for LAMF differs from the type of mutual fund pledged and the regulatory caps laid down by the Reserve Bank of India (RBI). For equity-oriented mutual funds, the regulatory LTV cap is at 75%, but most of the lenders provide up to 60% depending on their credit risk assessment. For debt funds, the LTV ratio may be entirely dependent on the loan policies of the bank.
In addition, lenders maintain a list of mutual funds eligible for LAMF, which may differ from one bank and NBFC to another depending on their credit risk policies. Borrowers must check whether their mutual funds are eligible for LAMF and compare the LTV ratios offered by different lenders before arriving at a decision.
2. Overdraft Facility
LAMF is generally provided as an overdraft facility. Based on the LTV ratio and market value of the pledged funds, a credit limit is sanctioned. The borrowers are at liberty to withdraw the whole limit or smaller amounts.
It charges interest only on the withdrawn amount, not the total sanctioned limit, till it is repaid. This flexibility makes LAMF a very useful tool for managing short-term financial needs while keeping long-term investment goals in place.
3. Flexible Repayment Terms
LAMF borrowers are usually allowed to service only the interest portion, and the principal can be repaid partially or wholly, at their discretion. Again, unlike traditional loans, LAMF does not have any form of prepayment charge that would limit the borrower from taking control of his servicing through cash flow.
4. Periodic Securities Revaluation
Since mutual funds are market-linked, the NAVs may change due to market conditions. The lenders revalue the pledged funds periodically and may also make interim revaluations during a market downturn.
If the NAVs have fallen significantly so that the LTV ratio exceeds its original limit, lenders may ask the borrower to pledge further securities or to make payments for the LTV ratio to be restored. Failure to do so could lead to a penalty, or even worse, to the liquidation of the pledged funds.
5. Credit Scores Less Important
Unlike unsecured loans, the credit score is of no particular importance for lenders providing LAMF since they can recover dues by redeeming the pledged mutual funds. Yet, credit scores can sometimes be considered by lenders in determining interest rates for LAMF applicants.
A Flexible Financial Solution
LAMF offers an easy mode of fulfilling short-term finance requirements without losing long-term investment objectives. Some benefits such as flexible repayment, no end-use restrictions, and least reliance on credit scores, which the LAMF has offered, make it a beneficial financial tool. However one needs to check all terms carefully, such as LTV ratios, eligible funds, and revaluation policies, while making a decision.
