Loans from banks and financial institutions serve as a lifeline for unexpected expenses or medical emergencies. Life’s surprises often leave us unprepared for financial demands. Fortunately, various loan options are available, whether you have assets to mortgage or not. In this blog, we delve into the variances, benefits, and limitations of loans against mutual funds (LAMF) and personal loans, providing you with the information needed to make a well-informed borrowing decision. Let’s begin!
Usual Challenges Faced During Immediate Cash Crunch
Facing a quick cash crunch can be incredibly stressful, mainly when essential expenses need to be protected.Common challenges include:
- Prioritizing Expenses: Essential costs such as rent, utilities, food, and medicine must be prioritized, often requiring cuts in discretionary spending.
- Food Insecurity: Many struggles to afford nutritious food, relying on food banks or cheaper, less healthy options, leading to nutrient deficiencies and decreased well-being.
- Debt Burden: Cash shortages can hinder debt payments, resulting in late fees and negative impacts on your credit score.
- Anxiety and Emotional Strain: Financial pressure can severely affect mental health, causing anxiety, stress, and emotional strain.
- Difficult Financial Decisions: Navigating options like selling belongings, borrowing money, or postponing bills can have lasting effects.
- Impact on Relationships: Financial strain often increases tension and conflict in relationships with partners, family, and friends.
- Limited Access to Credit: Financial constraints can make securing traditional loans difficult, exacerbating immediate financial needs.
- Feeling Ashamed or Embarrassed: The stigma of financial difficulties can hinder seeking support from loved ones or financial institutions.
What is a LAMF and How Does It Work?
A Loan Against Mutual Funds (LAMF) allows you to leverage your mutual fund units to access funds through an overdraft facility. Banks, financial institutions, and NBFCs like Investkraft enable you to digitally lien mark your funds and access necessary funds. The loan operates as an overdraft, permitting convenient access to funds and the flexibility to repay at any time without extra fees. Interest is applied only to the utilized amount and for the duration it is used.
Example of LAMF
Anjali, a software engineer in Bangalore, had substantial mutual fund investments. When faced with a sudden medical emergency, she chose to take out a loan backed by her mutual fund holdings instead of liquidating them. Her bank, where her mutual funds were in demit form, assessed her portfolio, valued at 10 lakh rupees, and determined she could borrow 6 lakh rupees based on a 60% LTV. The bank offered her a 10% annual interest rate, much lower than a personal loan. Her loan application was approved quickly, and funds were transferred within three days, allowing her to handle her emergency without affecting her investment strategy. Her mutual fund worth continued to be admired.
What is a Personal Loan and How Does It Work?
Personal loans provide borrowers with a lump sum of cash, which is repaid along with interest through regular monthly installments over the loan term. After approval, the loan amount typically goes directly into your checking account, providing immediate access to funds. Fixed-rate loans have constant monthly payments, while variable-rate loans may vary, resulting in changing amounts owed each month. Once the personal loan is fully repaid, the credit line is terminated.
A Side-by-Side Comparison of Personal Loans and Loan Against Mutual Funds (LAMF)
Choosing between a personal loan and a Loan Against Mutual Funds (LAMF) depends on your typical financial situation and requirements. Here’s a detailed analysis:
| Particular | Loan Against Mutual Fund | Personal Loan |
| Loan Type | Secured loan using mutual fund units as collateral | Unsecured loan based on creditworthiness |
| Interest Rate | Lower interest rates due to collateral | Higher interest rates based on creditworthiness |
| Loan Amount | Percentage of the Net Asset Value (NAV) of mutual funds | Higher loan amounts possible for substantial expenses |
| Repayment | Customizable repayment plan with flexible principal repayment | Fixed monthly installments (EMIs) |
| Impact on Investment | Risk of margin call if market value drops | No impact on investments |
| Processing Time | Longer processing due to asset assessment | Quicker processing and reduced paperwork |
How to Select If I Need a LAMF or a Personal Loan?
When assessing a loan against a mutual fund (LAMF) vs. a personal loan, weigh the pros and cons of each choice.
Go for LAMF if:
- You have mutual fund investments and seek a lower interest rate.
- You can handle potentially lower loan payments and market changes.
- You require a short-term loan, repayable at a later date.
Go for a Personal Loan if:
- You do not have mutual funds or do not wish to use them as collateral.
- You require a bigger loan amount for an exact intention.
- Your right credit score makes you suitable for a lower interest rate.
- You value the predictability of fixed monthly repayments.
Conclusion
Unexpected financial emergencies can disrupt your budget, but personal loans and loans against mutual funds (LAMFs) offer much-needed support. To make the best decision, carefully assess your financial circumstances and requirements. Considering the advantages and disadvantages of LAMFs and personal loans is important for making a well-informed conclusion that aligns with your financial circumstances and delivers support during tough moments.
Frequently Asked Questions (FAQs)
Q1: What are the implications if the value of my mutual fund holdings drops?
A: If the value of your holdings decreases substantially, you may need to deposit more cash or sell some units to maintain the required loan-to-value ratio.
Q2: Can you please provide information on the processing fees and any other charges related to LAMFs?
A: Potential processing fees, foreclosure charges, and annual maintenance charges should be considered when comparing the overall cost of a LAMF to that of a personal loan.
Q3: Are there any options for LAMFs and personal loans?
A: Alternatives such as securing a line of credit with your mutual funds or negotiating a payment plan with creditors could help avoid the need for a loan.
Q4: How can I ensure I’m making the best decision between a Loan against a mutual fund and a personal loan?
A: Create a detailed budget and examine your financial situation to determine how much you can realistically afford to borrow. Consider factors like interest rates, loan terms, and potential tax implications. Seeking advice from a financial advisor can also be valuable.
Q5: What should I do if I require emergency funds and have both a LAMF and a personal loan option?
A: Personal loans are faster if you need cash urgently. However, if you can wait a few days and the LAMF has a lower interest rate, it might be worth considering.
Q6: Is there a method to merge the advantages of a LAMF and a personal loan?
A: Using a combination of a LAMF and a personal loan to cover your funding needs can help you benefit from lower interest rates while ensuring sufficient funds. However, plan carefully and assess your ability to manage repayments for both loans.