What are the differences between loans against mutual funds and fixed deposits?

In the realm of Indian finance, loan against mutual funds (LAMF) and loan against fixed deposits (LAFD) stand as two popular options for borrowers seeking quick access to funds. While both these loans serve the same purpose, they differ significantly in their underlying principles, risks, and suitability for different individuals. This blog delves into the intricacies of LAMF and LAFD, providing a comprehensive overview of their key distinctions, application processes, and potential consequences of default.

Unveiling the differences: LAMF vs LAFD

Loan against mutual fund- A LAMF is a secured loan where borrowers pledge their mutual fund units as collateral to avail funds. The loan amount is determined by the value of the pledged units, with loan-to-value (LTV) ratios typically ranging from 50% to 75%.

Key advantages of LAMF:

• Liquidation of mutual fund units only if the borrower fails to repay.
• Offers flexibility to avail funds without disrupting investment plans.
• Relatively lower interest rates compared to personal loans.

Key disadvantages of LAMF:

• The value of pledged units may fluctuate, potentially triggering margin calls.
• Borrowers may face capital gains tax if units are sold to repay the loan.

Loan against fixed deposit (LAFD)- An LAFD is another secured loan where borrowers pledge their fixed deposits (FDs) as collateral. The loan amount is limited to a certain percentage of the FD value, with LTV ratios typically ranging from 75% to 90%.

Key advantages of LAFD:

• Fixed interest rate ensures predictable repayment costs
• No risk of collateral value fluctuations
• Interest earned on the FD continues to accrue

Key disadvantages of LAFD:

• Premature withdrawal of FD may result in penalty charges
• Interest rates are generally higher compared to LAMF
• Application process: Navigating the avenues

Applying for a LAMF procedure:

• Approach a financial institution: Banks, non-banking financial companies (NBFCs), and online lenders offer LAMF.
• Select the mutual fund scheme: Choose a scheme from the approved list provided by the lender.
• Pledge mutual fund units: Submit the necessary documentation to pledge the selected units as collateral.
• Receive loan amount: Upon approval, the loan amount is disbursed into your account.

Applying for an LAFD procedure:

• Visit your bank or NBFC: Approach the financial institution where your FD is held.
• Provide FD details: Share the details of the FD you wish to pledge as collateral.
• Complete the loan application: Fill out the required application form and submit supporting documents.
• Receive loan amount: Upon approval, the loan amount is credited to your linked account.
• Consequences of default: Understanding the implications.

What happens when you default on LAMF

• Margin calls: If the value of pledged units falls below a certain threshold, the lender may issue margin calls, requiring borrowers to deposit additional collateral or repay part of the loan.
• Liquidation of units: In case of prolonged non-compliance with margin calls, the lender may liquidate the pledged units to recover the outstanding loan amount.
• Impact on credit score: Defaulting on any loan can negatively impact your creditworthiness.

What happens if you default on LAFD

• Foreclosure of FD: The lender may foreclose on the pledged FD to recover the outstanding loan amount.
• Loss of interest: Interest earned on the FD will cease upon foreclosure, and any premature withdrawal penalties may apply if so stipulated in the terms and conditions.
• Impact on credit score: Defaulting on any loan can negatively impact your creditworthiness.

Interest rate comparison: Seeking the optimal deal

Generally, LAFDs offer lower interest rates compared to LAMFs. This is because FDs are considered less risky collateral compared to mutual fund units, which are subject to market fluctuations.

Timeline comparison: Speeding through the process

LAFDs typically have a faster processing time compared to LAMFs. This is because the value of the pledged FD is readily determinable, while the valuation of mutual fund units may take longer.

In conclusion, the choice between LAMF and LAFD depends on individual circumstances and risk tolerance. For those seeking quick access to funds without disrupting investments, LAMF may be suitable. However, if stability and predictable repayment costs are priorities, LAFD could outperform LAMF. In most situations, LAFD will attract lower interest rates in comparison to LAFD.

Kuvera is a free direct mutual fund investing platform.

Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.

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Updated: 24 Nov 2023, 01:14 PM IST