No matter how well you plan your finances, an emergency can throw them in a disarray. For instance, what do you do if your home loan EMI is due but you have no cash? Taking a loan to help tide over the rough period may seem like a good solution, but most people are hesitant as they have no idea what to offer as a collateral. What they don't realise is that if they own mutual fund units, they have a ready back-up. You can pledge these units and borrow money against them. This facility not only allows you to borrow at better terms, but also gives you the freedom to utilise the units without actually redeeming them.
Pledging the units as security is done by marking a lien on the required number of units. This means that the lien holder can legally use the asset to settle an unpaid loan. Since the value of units may fluctuate, the lender keeps a margin on their current value. For instance, if the value of units at the time of taking the loan is Rs 1 lakh, the investor may get a loan of up to Rs 70,000. This margin may vary from lender to lender, depending on the suitability of the units, which in turn depends on the fund scheme, its performance and history. As a unit holder, you will have limited rights during the period for which they are pledged.
Some banks offer loans at about 50% of the value of your holdings and set minimum loan thresholds. The lender also decides the mutual funds that can be used as security, the rate of interest on the loan and the margin limit. So, before you ask for a loan, check the eligibility of your mutual fund units.
Once a lien is marked, the investor and the lender need to inform the registrar and transfer (R&T) agent through a letter. The letter provides details such as the folio number, scheme, lien holder's bank account details and the number of units pledged. The R&T agent then sends back an account statement to the investor in which the creation of lien is recorded. The lien is created based on the number of units, not the amount of loan, which is decided after including the lender's margin. All the holdings in a folio may not be included in a lien. So, if an investor is holding 200 units of a scheme with an NAV of Rs 80, then for Rs 10,000 (including the margin) the lien will be created only for 125 units.
As an investor, you will also receive the benefits that may accrue from the mutual fund. For instance, the dividends that are declared will come to you, not to the lien holder, unless it has been specifically mentioned otherwise.
What happens if you are unable to repay the loan that you have taken against your mutual fund units? The lien is invoked when the lien holder decides to exercise it. The investor is informed about it through an account statement. Similarly, the lien is revoked when you, the borrower, repay the loan. The lien holder communicates the same in writing to the R&T agent and the lien is unmarked. Once this is done, you can begin conducting transactions for your units.
