Borrow Smart, Invest Wise: Guide to Loan Against Mutual Funds

Life throws financial curveballs, and sometimes, you need quick access to cash. Traditionally, investors would redeem their mutual fund units to meet such needs. However, this disrupts their long-term investment plans and could lead to potential capital gains tax implications.

Thankfully, an innovative solution exists: Loan Against Mutual Funds (LAMF). Let’s explore LAMF in detail, understand its advantages and disadvantages, and help you decide if it’s the right fit for your financial situation.

What is a Loan Against Mutual Funds (LAMF)?

A Loan Against Mutual Funds (LAMF) allows you to borrow money against the value of your existing mutual fund holdings. Consider it a loan using your mutual fund units as collateral. You don’t sell your investments; instead, you pledge them as security for the loan.

Benefits of Loan Against Mutual Funds (LAMF)

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Liquidity without Disruption: This is the primary advantage of LAMF. You access cash without selling your mutual funds, allowing your investments to continue growing potentially.
Lower Interest Rates: Typically, interest rates on LAMFs are lower compared to personal loans or credit cards. This translates to significant cost savings, especially for larger loans.
Faster Processing: Obtaining an LAMF is often quicker than applying for a fresh loan. The lender already has your investment details, streamlining the process.
Tax-deductible Interest: The interest you pay on the LAMF can potentially be deducted from your taxable income under Section 24(b) of the Income Tax Act, 1961. This applies if the loan is used for specific purposes like business expenses, investment in certain assets, or higher education where as tax on capital gains from mutual funds
- Equity Funds: For equity funds held for less than 1 year, short-term capital gains are taxed at 15% (plus applicable surcharge and cess). Equity funds held for more than 1 year attract Long Term Capital Gains (LTCG) tax. If the LTCG exceeds Rs 1 lakh per year, a 10% tax with indexation benefit applies.
- Debt Funds: Short-term capital gains from debt funds are taxed according to your income tax slab. LTCG from debt funds are taxed at a flat rate of 20% with indexation benefit.

Example:

Imagine you invested INR 5 lakh in a mutual fund that has grown to INR 7 lakh. An emergency expense of INR 2 lakh arises. Through LAMF, you can borrow INR 2 lakh against your INR 7 lakh mutual fund investment, without having to sell any units. Your mutual funds continue to grow potentially, and you may even enjoy tax benefits on the interest paid on the loan.

Things to Consider Before Opting for LAMF

Margin Requirement: Lenders provide a percentage of your mutual fund’s value (typically 50-75%) as a loan. A market downturn could trigger a “margin call,” forcing you to either top up the margin or sell some of your holdings.
Impact on Investment Returns: While you retain ownership of your mutual funds, the loan repayment obligation can impact your overall return on investment.
Tax Implications: Consult a tax advisor to understand the tax treatment of interest paid on LAMF and any potential capital gains implications if you sell holdings to meet a margin call.

Is LAMF Right for You?

LAMF can be a valuable tool if used strategically. Here are some situations where LAMF might be a good fit:

Short-term emergencies: For unexpected medical bills, urgent home repairs, etc., LAMF allows access to cash without disrupting your long-term investment goals.
Funding short-term goals: Need funds for a down payment on a two-wheeler or a child’s school admission? LAMF can be a better option compared to liquidating your entire investment.
Debt consolidation: If you have high-interest debt from credit cards or personal loans, consolidating it with a lower-interest LAMF can save you money. To get detailed guidance about LAMF click here.

Conclusion

LAMF offers a convenient way to access funds from your mutual funds without selling them. However, it’s crucial to understand the risks involved, like margin calls and potential tax implications. Carefully evaluate your financial situation and investment goals before opting for LAMF. Consulting a financial advisor can be extremely helpful in making an informed decision.