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One of the options available for investors in mutual fund (MF) units to raise cash is to take an overdraft facility against these units. This is usually available with most banks - private and public. At times when you require money for a short period of time, this can be a good choice as compared to selling the units.
However, before taking a final decision you need to carefully consider how exactly this works and evaluate whether it actually suits your specific need.
When to pledge
Sometimes investors may face a sudden need for funds. To meet this requirement the investor will have to either dip into his or her investments or look for some borrowings. In some cases, it may happen that the investor may decide to sell his existing investment in MFs to raise the required amount. This would mean a step back in the process of building a corpus because when the balance reduces, it will take away the benefit of compounding of the portfolio. To avoid this investors should look around for options to see that they suffer minimum financial damage at the end of the day.
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Get funds through an overdraft
Several banks offer the option of taking an overdraft against MF units. The benefit of this is that the investor gets to keep the investment that they have initially made and at the same time raise funds for to meet the immediate requirement.
It works like this. You go to the bank with the number of units you have in a certain MF. The units are pledged to the bank and it then agrees to lend against them up to a certain amount that is decided based upon the value of the units and the discounting factor that is available with the bank. A current account is opened with a specific limit. The investor can then withdraw the money up to the limit that has been sanctioned at the specified rate of interest. The key point here is that the withdrawal would be charged only when it is actually made. So, merely availing an overdraft limit does not impact the finances, that is, it does not involve any repayment.
Investors can pay back the money when they have the required funds and they will be charged interest only for the time that they have used the funds.
What to look for
Most banks offer this facility, so investors have a wide choice of which bank to approach. It is possible to pledge units of both equity and debt MFs. But there is one restriction. This facility is available only against those MF schemes that are specified by the bank for this purpose. Therefore, it is important for to look at the list of schemes with the bank before pledging their MF units.
Another factor to keep in mind is that banks will offer only a certain percentage of the fund value as the overdraft limit. In most cases, it is 50 per cent. This means that if the value of the units is Rs 1 lakh, then the bank will offer Rs 50,000 as overdraft limit.
This limit will vary from bank-to-bank. Usually, banks offer between Rs 50,000-2, 00,000 as the overdraft limit.
In terms of the cost, the interest rate varies between 11 and 14 per cent, depending on the bank. This is better than the rates offered for a personal loan, since overdraft against MF is a secured loan, while a personal loan is an unsecured loan. You can scout around and check which banks offer the lowest rate. If you already have a relationship with the bank, you can request for better rates. The bank will check the value of the portfolio at regular intervals, in many cases this could be weekly. This is done so that the total overdraft limit is adjusted accordingly. If the fund value dips, due to fluctuations in the market, the limit will be lowered. In case of a default the bank could ask the investor to sell the MF units in order to recover its money.
Suitable for short-term only
This route is suitable for investors who have MF units and want a small amount for a short period. The overdraft facility ensures that their cost is limited as they will pay only for the time period that they use the funds. Also, it allows for flexibility in the paying back. So, this route is useful if you are not sure that you will be able to repay the money in a linear fashion. This option allows investors to retain their investments and at the same time raise funds against it to meet any emergency.
The author is a certified financial planner
