Mutual funds have become an integral part of many investors' portfolios over the years. With good returns potential and diversity, mutual funds can be useful for various financial goals. However, there may be situations when you require funds for emergencies or other expenses but do not want to redeem your investments. This is where taking a loan against mutual funds can help.
Financial institutions may offer loans against mutual funds at competitive interest rates, allowing you to access liquidity while your investments remain in place. However, this option is not available for all types of mutual funds and eligibility criteria can differ by lender. Like any other loan, borrowing against mutual funds needs to be done carefully. Here are some mutual fund loan best practices you must follow for using loans against your investments wisely.
1. Assess Your Need for Funds
Before taking a loan against mutual funds, check why you need the money and if a loan is the best option. These loans suit short-term emergencies, not long-term goals. For big future expenses, selling investments might be better. Also, ensure your income can cover repayments comfortably. Don’t borrow more than you can repay.
2. Choose the Right Scheme
Not all mutual funds allow you to borrow against them. Most open-ended equity schemes permit loans, but debt schemes often do not. The loan amount, interest rate, terms, and fees vary between mutual fund companies and specific investment schemes.
Before choosing a loan, compare these factors across different providers:
- Maximum loan amount
- Interest rate
- Loan term length
- Foreclosure and early repayment policies
3. Analyse All Costs Involved
Interest is not the only cost. There may be processing fees, prepayment penalties, foreclosure charges, and bounce fees. Consider all charges to find the most cost-effective loan, even if interest rates seem higher.
4. Smart Borrowing Against Mutual Funds
A common mistake many investors make is over-leveraging mutual fund loans without considering repayment ability. One should know when to use a mutual fund loan. As one of the most prudent mutual fund loan best practices, limit your loan amount to 60-70% of your mutual fund portfolio value. This allows you to sufficiently meet your requirements while minimising risk. The remaining investments can continue generating returns to grow your wealth.
5. Use Loan Amount Wisely
Only borrow if you really need to. Use the loan for essential expenses, not wants. Borrowing for unnecessary spending can cause financial trouble. Be careful and responsible with your loan.
6. Have a Repayment Plan
Plan how you will repay before taking the loan. Use your steady income to start repayments right away. Many lenders offer flexible options, but discipline is key to repay fully on time.
7. Manage Your Investments
Before taking a loan against mutual funds, you should prepare an effective repayment plan instead of relying on spare cash flows later. Structure your repayments based on predictable income streams so that you can start repaying immediately without defaulting. Focus on protecting your wealth until the loan is repaid. Losses during this time can hurt your ability to repay and reduce your savings.
8. Monitor Interest Costs
One risk involved in mutual fund loans is fluctuating interest costs since most institutions charge a floating rate of interest. If interest rates rise significantly during your loan tenure, your interest outgo could be higher than planned. To mitigate this risk, monitor interest rate trends and prepay part of your loan if you have surplus funds. Many financial institutions allow part-prepayment of loans without hefty charges.
9. Avoid Further Borrowing
The first step to managing mutual fund loans is to avoid further borrowing against your investments till the time you have repaid your existing loan. Additional borrowing can severely impact your ability to generate wealth from your investments and also make repayments difficult leading to defaults or extensions. Allow your investments to grow while being disciplined with your repayments.
10. Follow Foreclosure Guidelines
Many borrowers prepay or foreclose their loans earlier than the full tenure to minimise interest costs. However, financial institutions may have specific foreclosure guidelines regarding notice periods or charges. Follow the set guidelines strictly to avoid any penal costs. Some institutions waive off foreclosure charges on meeting certain conditions.
11. Learn From Every Experience
Each loan experience teaches you how to borrow better next time. Review what worked and what didn’t to improve your future decisions.
The Bottom Line
Loans against mutual funds provide useful access to liquidity to meet your needs if used judiciously. By following these smart mutual fund loan best practices and guidelines, you can meet your objectives without taking excessive risk. However, discipline while borrowing funds and repaying mutual fund loans is vital for this to remain a mutually beneficial proposition for both investors and lending institutions. Avoid aggressive borrowing and defaulting on loans to build a good credit history, which comes in handy during times of need.
