How to Borrow Money Against ELSS Mutual Funds and Stay Invested at the Same Time?

May 21st 2024
Loan
Loan Against ELSS Mutual Funds

The new offering of Loan Against ELSS Mutual Funds allows investors to unlock the potential of their investments while meeting their financial needs. This option will enable investors to avail a loan against their ELSS investments without having to redeem them, which can be beneficial during financial emergencies. Investors can stay invested in ELSS while accessing funds through this loan facility, thus providing a diverse range of benefits. 

Now, you no longer have to make a difficult choice between long-term investments and short-term financial needs. By taking a loan against your ELSS funds, you can enjoy the freedom to handle unexpected expenses and seize investment opportunities. Moreover, you can also meet urgent financial requirements without sacrificing the growth of your ELSS investments. 

Investors can now unlock the value of their ELSS investments by taking loans against them, which is a modern and innovative financial move. This allows them to access liquidity without disrupting their wealth-creation journey. It is a strategic play that empowers investors and provides them with additional financial flexibility. 

What is the Simple Definition of a Loan Against ELSS Mutual Funds?

Loan against ELSS mutual funds allows you to use your Equity Linked Savings Scheme mutual fund units as collateral to borrow money. It is a financial arrangement that provides you with the opportunity to access funds while keeping your investments intact. 

Example:

  • If you have invested in ELSS mutual funds for tax-saving reasons but now need money for a short-term expense, rather than selling your ELSS units and risking long-term gains, consider getting a loan against the units. The loan amount is based on the current value of your ELSS units and can be used for a variety of purposes, such as paying medical bills, covering education expenses or addressing unexpected financial needs. 

What are the Eligibility Criteria to Apply for a Loan Against an ELSS Mutual Fund?

Here are the eligibility criteria to apply for a loan against an ELSS Mutual Fund (sources: Bajaj Finserv & FundsIndia) - 

Particular

Eligibility Condition

General Eligibility

  • Resident: To avail of a loan against the ELSS mutual fund, you need to be a resident of India with a valid address
  • Age: The majority of lenders typically accept borrowers between the ages of 18 and 75
  • Credit Score: Many lenders prefer a minimum credit score of 750 or higher

ELSS Specific Eligibility

  • Minimum Investment: Your ELSS fund requires a minimum investment value. The amount may vary depending on the lender, however, it typically starts at 50,000 rupees
  • Listed Scheme: To avail of a loan, the ELSS fund you possess must be from a pre-approved list of schemes endorsed by the lender

Additional Eligibility Criteria

  • Non-resident Indians (NRIs) typically do not qualify for loans using Equity Linked Savings Scheme (ELSS) funds as collateral
  • The loan amount is calculated on the loan-to-value (LTV) ratio defined by the lender, usually ranging from 50% to 75% of the ELSS fund’s worth. This means that the amount you can borrow will be a percentage of the value of your ELSS fund

Loan Against ELSS Mutual Funds: Documents Required and Application Form

We have already discussed the list of documents you need to apply for a loan against mutual funds through Investkraft along with the detailed LAMF application process. You can check out the same from the links provided above. 

What are the Advantages of Taking a Loan Against ELSS Mutual Fund?

Taking a loan against ELSS mutual funds can offer several advantages like - 

  • Liquidity without disrupting your investment: A major benefit of taking a loan against ELSS is that it allows you to access funds for short-term needs without disrupting your investment. ELSS funds typically have a 3-year lock-in period, which means you cannot withdraw your money during that time. By taking a loan, you can avoid selling your investments and potentially missing out on long-term capital appreciation.
  • Lower interest rates than other options: Taking out a loan secured by your ELSS units allows you to benefit from lower interest rates compared to unsecured loans such as personal loans or credit cards. This is due to the reduced risk for the lender, as they have the collateral of your ELSS units, providing you with a more cost-effective borrowing option.
  • ELSS funds can still earn returns: ELSS funds can still earn returns even when used as collateral. They can continue growing and generating profits.
  • Convenience: Some lenders provide the convenience of online applications and fast approval processes for loans secured against mutual funds. His streamlined approach can save time and hassle for borrowers, allowing them to access funds more efficiently when needed. With the ability to complete the application process online, borrowers can enjoy greater flexibility and convenience when seeking these types of loans.

Important Considerations Before Taking a Loan Against ELSS Mutual Funds

Here are some important considerations before taking a loan against Equity Linked Saving Schemes (ELSS) mutual funds - 

Particular

Points to Consider

Impact on Investment and Growth

  • Locked-in Funds: When you take a loan against ELSS, your mutual fund units are used as collateral and cannot be redeemed or switched during the loan period, possibly causing you to miss out on market gains
  • Disrupted Investment Strategy: It can disrupt long-term investment plans and goal

Loan Details and Repayment

  • Interest Rates and Fees: Compare interest rates and fees of different lenders for loans against mutual funds 
  • Loan Eligibility and Loan-to-Value Ratio (LTV): Eligibility for loans against ELSS funds may vary among lenders, with some having minimum investment value requirements. In such cases, the loan amount is generally determined based on a percentage of the value of the pledged units, also known as the LTV ratio, which is set by the lender

Alternatives and Risk Management

  • Consider Alternatives: Try other options before using a loan against your ELSS, like a credit card or line of credit
  • Market Volatility: ELSS funds are subject to market volatility. If the value of your unit drops significantly during the loan term, you may be required to sell your investments at a loss to repay the loan

Tax Implications

Using ELSS funds as loan collateral may reduce the tax advantages they offer under Section 80C. Additionally, the interest paid on the loan might not be tax-deductible, which should be considered when calculating the overall cost of borrowing

Early Redemption Charges

ELSS funds usually require a minimum investment period of 3 years. If you need to sell units that are pledged as collateral to repay a loan before the 3 years are up, you might have to pay exit loads, which could diminish your overall returns

Impact on Credit Score

Missing loan repayments for your ELSS can significantly harm your credit score, potentially impacting your ability to secure future loans. It is important to ensure that you make timely repayments to protect your creditworthiness and financial credibility

Portfolio Diversification and Asset Allocation

  • Concentration Risk: Taking a large loan against your ELSS holdings increases concentration risk. Market downturn could impact the value of pledged units and potential return
  • Rebalancing Portfolio: ELSS can disrupt asset allocation. Rebalance portfolio after repaying loan to maintain long-term investment strategy

Margin Calls and Forced Selling

The lender establishes an LTV ratio and if the value of your pledged units drops below a certain threshold, the lender can issue a margin call. This call requires you to either deposit more funds or sell some of your units to maintain the LTV, which could result in a potential loss

Tax-Efficient Alternatives

Exploring the option of a top-up on a lower-interest loan, such as a home loan, could be a more tax-efficient way to access funds. This approach may offer advantages over taking a loan against ELSS, which could potentially cancel out certain tax benefits. Consider your circumstances before making a decision

Conclusion

Loans against ELSS mutual funds provide investors with a strategic solution to meet short-term financial requirements while preserving long-term investment goals. These loans offer a distinct advantage by providing liquidity without the need for redemption. 

Investors can benefit from leveraging their ELSS holdings to access funds without having to sell units and potentially miss out on market gains. This is especially helpful in avoiding the common concern for traditional ELSS lock-in periods.

Furthermore, ELSS mutual funds usually offer loans with lower interest rates than unsecured loans, resulting in substantial savings for borrowers. 

Responsible planning is essential when considering a loan. Factors such as interest rates, loan-to-value ratios and market volatility should be carefully considered. Exploring alternatives and making timely loan repayments is important to protect your credit score and investment goals. 

Utilizing loans against ELSS mutual funds strategically ensures a balanced approach to meeting short-term financial needs without compromising long-term financial success. 

Frequently Asked Questions (FAQs)

Q: How Does a Loan Against ELSS Mutual Funds Work?

A: When taking a loan against ELSS mutual funds, you pledge your units as security to the lender who will grant you a loan amount based on a percentage of the NAV. The NAV represents the market value of a single unit of the mutual fund scheme. Once you receive the loan, you can utilize the proceeds for any purpose

Q: Is a Loan Against ELSS Mutual Funds Right for Me?

A: Taking a loan against an existing ELSS investment can provide immediate liquidity for short-term needs, but it is crucial to evaluate your financial situation and risk tolerance. If you are comfortable with market fluctuations and have a high-risk appetite, this option may be suitable. However, if you prioritize the long-term growth of your ELSS investment and are risk-averse, alternative options such as emergency funds or credit cards might be more suitable for you

Q: Are there any tax benefits associated with the interest payments made on a Loan Against ELSS Mutual Funds?

A: No, interest payments on a loan against ELSS mutual funds are not tax-deductible in India. They are considered personal expenses and are not eligible for deductions under Section 80C or other relevant sections of the Income Tax Act

Q: Can I use a Loan Against ELSS Mutual Funds for any purpose?

A: It is essential to be mindful of the fact that the loan is backed by your investment, so using the funds for non-essential expenses may expose your investment to risk, particularly during market downturns. It is generally recommended to utilize the loan for genuine short-term needs or unexpected financial emergencies

Q: Can I take a Loan Against ELSS Mutual Funds from any type of mutual fund scheme?

A: No, not all ELSS mutual fund schemes can be used for loans. Lenders have specific criteria for eligibility, including fund size, performance and liquidity. It is important to confirm with your lender which ELSS schemes they accept for a loan against mutual funds

Q: What is the typical loan term for a Loan Against ELSS Mutual Funds?

A: The loan term for a Loan Against ELSS Mutual Funds is flexible and can vary based on the lender’s options. Generally, loan terms fall within the range of 12 to 36 months, but some lenders might have different terms for their specific products

Q: What happens to my Loan Against ELSS if I decide to sell my investments entirely?

A: Selling your ELSS investment holdings requires closing the loan against ELSS funds, including repayment of the outstanding loan amount and any accrued interest. Only then can you access the remaining funds

Q: Can I make partial repayments on my Loan Against ELSS Mutual Funds?

A: Before making partial prepayments on your loan against ELSS, it is important to verify with the lender if there are any prepayment charges involved. This strategy can effectively reduce your loan amount and minimize the overall interest cost, but it is crucial to understand all the potential fees. Always ensure that you have a clear understanding of the terms and conditions before proceeding with any prepayments

Q: Is it advisable to take a Loan Against ELSS Mutual Funds for long-term financial goals?

A: Taking out a loan against your ELSS is generally not advisable for long-term financial objectives. ELSS investments are specifically intended for a long-term horizon for at least 10 years to take advantage of potential capital growth. Introducing a loan tied to your investment exposes you to market risks and could interfere with your long-term investment plan. It is worth exploring alternative investment options with a lower risk profile for your long–term goals

 

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