Loan Against Mutual Funds, Shares, and Bonds: What’s the Difference?

Regarding leveraging investments to meet financial needs, loans against mutual funds, shares, and bonds have gained popularity. These financing options allow you to unlock the value of your investments without having to sell them.

In this article, we will explore the differences, benefits, and considerations for each of these options, ensuring you have a comprehensive understanding.

What Is a Loan Against Investments?

A loan against investments allows you to borrow funds by pledging your financial assets such as mutual funds, shares, or bonds as collateral. Unlike unsecured loans, these loans are secured, typically offering lower interest rates. The lender retains a lien on the pledged assets, and their value determines the loan amount.

Loan Against Mutual Funds

How It Works:

To secure a loan against mutual funds, you pledge your mutual fund units with the lender. This can be done digitally with most financial institutions. The lender evaluates the value of your holdings to determine the loan amount, which is often up to 50-70% of the net asset value (NAV) of the funds.

Benefits:

1. No Need to Sell Units: You can continue to enjoy potential returns on your investments, including dividends.
2. Quick Processing: The process is relatively fast, especially with digital pledging.
3. Flexible Use of Funds: The borrowed amount can be used for various purposes like emergencies, education, or business.

Considerations:

1. Market Dependency: The value of your pledged mutual funds can fluctuate with market conditions, affecting the loan’s margin.
2. Limited Loan-to-Value Ratio: This depends on the type and volatility of mutual funds.
3. Interest Rates: While lower than personal loans, interest rates may still vary based on your lender and creditworthiness.

Loan Against Shares

How It Works:

When you opt for a loan against shares, your equity holdings are pledged as collateral. The loan amount is based on the market value of the shares, typically ranging from 50-75% of the value.

Benefits:

1. Retain Ownership: Similar to mutual funds, you retain ownership of your shares and can benefit from any price appreciation or dividends.
2. High Loan Amount: Given the high liquidity of shares, you may qualify for a higher loan amount compared to some other assets.
3. Quick Disbursal: The process is seamless with digital pledging, making it an excellent option for urgent financial needs.

Considerations:

1. Market Volatility: The fluctuating nature of share prices directly affects the value of your collateral and may lead to margin calls.
2. Eligible Shares: Not all shares are accepted as collateral; only certain listed stocks with adequate liquidity may be eligible.
3. Loan Tenure: Typically shorter than other loans, with some lenders offering tenure up to 1 year.

Loan Against Bonds

How It Works:

You can use bonds like government securities, corporate bonds, or tax-free bonds as collateral to obtain a loan. Bonds, being stable financial instruments, are often highly accepted for secured loans.

Benefits:

1. Lower Risk: Bonds have a lower risk profile compared to shares and provide steady collateral value.
2. Attractive Loan Terms: Due to their stability, loans against bonds often come with favorable interest rates and terms.
3. Preserve Investment Benefits: If you pledge tax-free bonds, you continue to receive the tax benefits associated with the bonds.

Considerations:

1. Longer Processing Time: Pledging bonds may require a bit more time than digital mutual funds or share loans.
2. Limited Loan-to-Value: This is generally lower compared to loans against shares or mutual funds.
3. Specific Bonds: Some lenders may accept only AAA-rated bonds or those issued by the government.

Key Differences Between Loans Against Mutual Funds, Shares, and Bonds

1. Loan-to-Value Ratio (LTV):

• Mutual Funds: Up to 70%.
• Shares: Typically 50-75%.
• Bonds: Around 50-60% depending on the bond’s type and credit rating.

2. Collateral Value Stability:

• Mutual Funds: Moderate, based on the fund’s NAV and underlying assets.
• Shares: Highly volatile; changes with market fluctuations.
• Bonds: Stable, especially government or high-rated bonds.

3. Purpose and Tenure:

• Mutual Funds and Shares: Suitable for short- to medium-term needs and can be used in various ways.
• Bonds: Preferred for medium to long-term financial requirements due to their stability.

4. Eligibility and Approval:

• Mutual Funds: Simple and fast digital process with eligibility for most individual investors.
• Shares: Limited to listed stocks and involves monitoring share prices.
• Bonds: These may involve more stringent credit checks based on the issuer and type.

Choosing the Right Option

Your choice between a loan against mutual funds, shares, or bonds depends on:

1. Your Immediate Needs: Loans against mutual funds and shares work well for urgent requirements, while loans against bonds are better suited for planned needs.
2. Market Awareness: If you are comfortable with market fluctuations, shares or mutual funds can be leveraged. For stability, bonds are preferable.
3. Investment Portfolio: Ensure the investment you pledge aligns with your financial goals and can withstand market risks without significantly affecting your financial health.
4. Lender Terms: Compare interest rates, processing fees, and tenure across financial institutions to select the most favorable option.

Conclusion

Loans against mutual funds, shares, and bonds offer a practical way to access liquidity without liquidating your assets. They come with distinct benefits and considerations, making it crucial to understand which option suits your financial situation.

By evaluating the loan-to-value ratio, risk tolerance, and repayment capabilities, you can effectively decide which type of loan aligns with your goals. Always remember to assess your repayment capacity and seek professional advice to ensure your investments continue to support your long-term financial aspirations.