With growing financial awareness, individuals actively seek ways to build wealth and secure their future. Investing in mutual funds and life insurance policies are two popular assets used in this regard. However, when financial needs arise, these assets should also be considered vs. personal or unsecured loan options. Individuals can leverage existing investments to secure a loan at lower interest rates. Sometimes liquidating assets also makes sense, whilst at other times the penalties are high and leverage is a better option. Assets like life insurance policies that are intended for future financial security can be used as collateral to secure loans at lower interest rates.
Two common options for asset-backed borrowing are Loans Against Mutual Funds (LAMF) and Loans Against Life Insurance (LAI). Both allow individuals to access funds without selling their investments, ensuring they continue to grow while serving as collateral.
Understanding Loans Against Mutual Funds (LAMF)
A Loan Against Mutual Funds (LAMF) allows investors to pledge their mutual fund holdings as collateral to secure an instant loan from a bank or NBFC. The lender provides a credit line or a lump sum amount based on the market value of the pledged mutual funds.
Loan Amount & Loan-to-Value (LTV):
- Equity Mutual Funds: Lenders typically offer up to 50-70% of the Net Asset Value (NAV).
- Debt Mutual Funds: Loans can reach up to 80-85% of the NAV.
Repayment & Usage:
- Borrowers can access funds without redeeming their investments, ensuring continued participation in market movements.
- Interest is charged only on the amount utilized, and the overdraft (line of credit) facility is typically valid for 12 months, subject to renewal.
Where Can You Get a Loan Against Mutual Funds?
- Banks & NBFCs: Major lenders like HDFC Bank, ICICI Bank, and Bajaj Finserv offer LAMF.
- Fintech Platforms: Companies like Volt Money, 50Fin and Yenmo provide seamless digital loan solutions against mutual fund holdings.
Risk Considerations:
- If the market value of the pledged mutual funds declines, lenders may issue a margin call, requiring borrowers to provide additional collateral or partially repay the loan to maintain the agreed LTV ratio.
Understanding Loans Against Life Insurance (LAI)
A Loan Against Life Insurance (LAI) allows policyholders to borrow against the Surrender Value of their life insurance policy. The insurer or a third-party lender provides a secured loan based on the policy’s accumulated value.
Loan Amount & Loan-to-Value (LTV):
- Traditional Life Insurance Policies: Loans are typically granted at 80%-90% of the surrender value.
- ULIPs: Due to market fluctuations, LTV is generally lower, around 50-60% of the fund value.
Repayment & Impact on Policy:
- The policy remains active as long as premium payments continue. If premiums are not paid, the policy may lapse, impacting coverage and benefits.
- If loan repayments are missed, lenders may surrender the policy to recover the loan amount. Any remaining balance is settled with the borrower.
Where Can You Get a Loan Against Life Insurance?
- Banks & NBFCs: Leading lenders such as SBI, HDFC Bank, ICICI Bank, Abhiloans, Svakarma, many Regional Rural Banks and Cooperative Banks provide loans against life insurance policies.
- Insurance Companies: Some insurers directly offer policy loans to their customers.
To understand better, let’s compare Loan Against Mutual Funds versus Loan Against Insurance based on key factors such as LTV, interest rates, processing time, and repayment flexibility to help you make informed financial decisions.
Comparing Loan Against Mutual Funds vs. Loan Against Insurance
Making the Right Choice for You
If you have both assets and can’t decide whether to leverage, and if so, which one to leverage, evaluate based on factors such as the value required, liquidity, repayment flexibility, and long-term financial impact.
Scenario 1: Loan Against Mutual Funds
You have a ₹10 lakh equity mutual fund portfolio, which has grown from your initial investment of ₹7 lakh over the past 2 years. You need liquidity but don’t want to redeem your investment and incur capital gains tax.
- Loan Amount at 60% LTV: ₹6 lakh
- Interest Rate: 11% p.a.
- Loan Tenure: 12 months (overdraft facility)
- Total Interest Cost (if fully utilised): ₹66,000/-
Alternative: Redemption vs. Loan
If you redeem ₹6 lakh, your taxable gain would be calculated proportionately:
- Your total capital gain is ₹3 lakh (₹10 lakh – ₹7 lakh).
- Redeeming ₹6 lakh means realising 60% of this gain, i.e., ₹1.8 lakh.
- At a 12.5% LTCG tax rate, the tax payable would be ₹22,500/-.
In this case, taking a Loan Against Mutual Funds (LAMF) allows your investment to continue growing while giving you liquidity. However, the LTCG tax will still apply whenever you redeem in the future.
When to Choose a Loan vs. Redemption?
- If you expect your investment to grow faster than the loan interest cost (11%), it makes sense to take the loan.
- If you're uncertain about market movements, redeeming might be safer to avoid debt and interest costs.
- If your ₹7 lakh investment had fallen to ₹6 lakh, you might hesitate to redeem at a loss. Expecting a market recovery, you could opt for a loan instead of selling at a lower value. However, your loan amount would be smaller (₹3.6 lakh at 60% LTV), and you'd still need to ensure that the market upswing covers the interest cost of ₹66,000/-.
Scenario 2: Loan Against Traditional Life Insurance Policy
You have a traditional life insurance policy that matures in 12 years, with a surrender value of ₹5 lakh and a current value of ₹10 lakh. You need short-term liquidity but don’t want to surrender the policy prematurely, as surrendering now would result in a loss of a significant part of your accumulated savings, benefits and future bonuses, potentially more than ₹5 lakh .
- Loan Amount at 90% LTV: ₹4.5 lakh
- Interest Rate: 11% p.a.
- Loan Tenure: 12 months (overdraft facility)
- Total Interest Cost (if fully utilized): ₹49,500/-
Alternative: Surrender vs. Loan
- If you surrender the policy, you get ₹5 lakh, i.e. the surrender value, and lose ₹5 lakh in accumulated savings in this example - typically 10-70% of accumulated savings and interest.
- Taking a loan against your policy allows you to access funds while keeping the policy active, avoids the significant surrender loss and ensures continued coverage and future maturity benefits.
Scenario 3: Loan Against ULIP Policy
As with equity mutual funds, the Loan-to-Value (LTV) ratio for ULIPs is lower due to market volatility. However, unlike mutual funds, ULIP policies have a mandatory 5-year lock-in period, as per IRDAI regulations, meaning policyholders cannot withdraw funds during this time.
If you need liquidity during the lock-in period, you can leverage your ULIP to get a loan from RBI-regulated banks and NBFCs, without surrendering your policy prematurely.
For example, you have a ULIP policy with a fund value of ₹10 lakh, fully invested in equity. You are currently in the 4th year of the lock-in period and need urgent liquidity. Since premature withdrawals from a ULIP are not allowed, liquidating this asset isn’t an option. Additionally, staying invested allows you to continue benefiting from potential market gains.
Instead of surrendering your policy, you can avail a Loan Against ULIP, ensuring you retain your investment while accessing the required funds.
Loan Terms:
- Loan-to-Value (LTV): 60%
- Eligible Loan Amount: ₹6 lakh
- Interest Rate: 11% p.a.
- Loan Tenure: 12 months (overdraft facility)
- Total Interest Cost (if fully utilised): ₹66,000/-
Note: Surrendering a Unit Linked Insurance Plan (ULIP) before its maturity can lead to several financial implications beyond capital gains tax. Here's a breakdown:
Surrender Charges:
Within the 5-Year Lock-In Period: ULIPs have a mandatory 5-year lock-in period. Surrendering during this period incurs discontinuance or surrender charges, which are deducted from your fund value. These charges vary by insurer and policy terms but are typically higher during the initial years. For instance, charges can range from ₹1,000 to ₹6,000, depending on the premium amount and the year of discontinuance.
After the Lock-In Period: Post the 5-year lock-in, surrender charges usually reduce significantly or may be entirely waived. However, this depends on the specific policy terms.
Alternative Options:
- Partial Withdrawals: If your ULIP has completed the 5-year lock-in period, you can access liquidity via partial withdrawals - up to 20% of the fund value, tax free if you meet the criteria. If this amount is sufficient, it’s an efficient way to maintain insurance coverage while accessing funds tax-free. However, if your liquidity needs are higher and you don’t wish to lose your insurance coverage, then taking a loan against ULIP is a better option.
- Surrender: Post the 5 year lock-in period, the entire fund value can be redeemed, but would be subject to 12.5% LTCG Tax as well as surrender fees as stated above.
Conclusion
Both Loans Against Life Insurance and Loans Against Mutual Funds provide effective ways to access liquidity without liquidating long-term investments. If you have a life insurance policy with a surrender value, opting for a Loan Against Life Insurance ensures you maintain coverage while leveraging the accumulated value and avoiding surrender loss. If you hold a substantial mutual fund portfolio, a Loan Against Mutual Funds allows flexible borrowing while letting your investments continue to grow and maintain the financial discipline you have cultivated.
Choosing the right option depends on the math given market conditions, liquidation options and factors such as liquidity needs, taxation, interest rates, and repayment flexibility. Understanding the nuances of each loan type will help you make an informed financial decision that aligns with your short-term and long-term goals. Always weigh-up liquidating the asset vs. leverage. With mutual funds it could often be beneficial to redeem rather than leverage, whilst with life insurance redemption or surrender is typically a poor financial outcome for the customer, and leverage is a better choice.
For help with navigating the best option for your context, please reach out to Mera Kal support via Whatsapp. To explore other secured loan options for your needs, use our Sahi Secured Loan Tool.