Have you ever wondered how you can compare LAMF against a personal loan? In this article, let us analyze a Loan Against Mutual Funds (LAMF) with an interest rate of 10.5% p.a. to a Personal Loan with an interest rate of 11.5%. To make you understand, we’ll use real-life examples to illustrate the cost differences and help you make a more informed choice.
Understanding the Loan Types
Loan Against Mutual Funds (LAMF): This is a secured loan where your mutual fund investments are collateral. Because the loan is backed by assets, lenders offer lower interest rates compared to unsecured loans. The major advantage is the lower cost of borrowing, but remember, your investments are at risk if you default.
Personal Loan: A Personal loan is unsecured, meaning it doesn’t require collateral as it is based on your credit history, credit score, income stability etc. As a result, lenders charge higher interest rates to compensate for the increased risk. This type of loan can be advantageous if you prefer not to use your investments or assets as security.
Interest Rates and Their Impact
1. Interest Rate on LAMF: 10.5% pa – This rate is relatively competitive for a secured loan. The lower risk for lenders generally translates into lower interest rates. However, one big advantage of LAMF is that it is created as a limit and you are charged interest only on the amount utilised by you and for the time period. There are no prepayment or foreclosure charges involved when you use this facility with Neoble. However, it’s important to assess how fluctuations in your mutual fund’s value might affect your overall financial situation. Check our LAMF Interest Calculator
2. Interest Rate on Personal Loan: 11.5% – With an 11.5% interest rate, a personal loan is slightly more expensive compared to the LAMF. However, in most of the cases this comes with prepayment penalty and/or foreclosure charges, which ranges anywhere between 1 to 3% of the outstanding loan amount. Despite the higher rate, the advantage of an unsecured personal loan is that you do not have to risk your investments. This could be beneficial if you value financial flexibility and lower risk. However, please note that personal loan interest rates can vary significantly based on your creditworthiness or credit score.
Real-Life Examples
Example 1: Loan Against Mutual Funds
Suppose you have mutual funds worth ₹5,00,000 and need a loan of ₹2,00,000. Opting for a Loan Against Mutual Funds with a 10.5% interest rate, and a loan tenure of 2 years, the costs breakdown is as follows:
– Principal Amount: ₹2,00,000
– Interest Rate: 10.5%
– Loan Tenure: 2 years
Using a standard loan calculator, an interest of Rs.1,750 only to be paid on a monthly basis (should you utilise the full amount of Rs.2 lacs). At the end of the maturity, you are liable to repay Rs.2 lac principal amount. This reduces the monthly burden of EMI, which is much higher than the interest only component. Total repayment therefore stands at 2.42 lacs as principal is not repaid during the entire tenure.
Example 2: Personal Loan
Now consider a personal loan of ₹2,00,000 with an 11.5% interest rate and a tenure of 2 years:
– Principal Amount: ₹2,00,000
– Interest Rate: 11.5%
– Loan Tenure: 2 years
In this scenario, the total interest payable over two years would be around ₹25,000. Thus, the total repayment amount would be ₹2.25 Lacs due to the reducing balance. However, the monthly EMI you will have to pay is Rs.9,368 as compared to LAMF monthly repayment of Rs.1,750.
Fetch Your Mutual Fund Loan Portfolio
Key Considerations
1. Collateral vs. Unsecured Loans: Weigh the risk of losing your investments with a LAMF against the higher cost of borrowing with an unsecured personal loan. If you are not comfortable with putting your investments at risk, a personal loan might be a safer option.
2. Total Cost of Borrowing: Consider both the total interest paid and any additional fees associated with the loan. Sometimes, a lower interest rate might come with higher fees or stricter terms that could impact the overall cost.
3. Loan Processing Time: Personal loans often have a quicker processing time since they don’t require collateral verification. If you need urgent access to funds, this could be a crucial factor.
4. Flexibility and Repayment Terms: Compare the flexibility in repayment terms, prepayment options, and other features of both loans. Sometimes, the ability to repay early or choose flexible payment options can outweigh the differences in interest rates.
4. Interest Only versus EMI: As explained earlier, in LAMF you may continue to avail the facility by repaying just the monthly interest component and enjoy higher limits all through the tenure. In case of Personal loan, a higher EMI is to be paid (Rs.1,750 Vs. Rs.9,368).
Frequently Asked Questions (FAQs)
1. What happens if I default on a Loan Against Mutual Funds?
If you default on a Loan Against Mutual Funds, the lender has the right to liquidate your mutual fund investments to recover the outstanding loan amount. This could affect your investment portfolio and future returns. Any default will be reported to the credit bureaus and your credit rating will be impacted negatively.
2. Are there any tax implications for taking a Loan Against Mutual Funds?
No, the interest paid on a Loan Against Mutual Funds is not eligible for tax benefits under Section 24 of the Income Tax Act, as it is not used for the purchase of a house or other specified purposes.
3. Can I prepay a Personal Loan or Loan Against Mutual Funds without penalties?
With Neoble, you have no prepayment penalties or foreclosure charges. Most lenders allow prepayment, but terms vary. Personal loans might have prepayment penalties or charges, so it’s essential to check the loan agreement or consult with your lender about prepayment options and any associated fees.
4. How quickly can I get funds from a Personal Loan compared to a Loan Against Mutual Funds?
Personal loans typically have a faster disbursal time since they don’t require collateral verification. Funds might be available within a few days. In contrast, a Loan Against Mutual Funds might take longer due to the need for asset evaluation and documentation. At Neoble, we offer this service with a turnaround time of 4 hours.
5. Which loan is better for improving credit score: Personal Loan or LAMF?
Both types of loans can improve your credit score if you make timely payments. However, since personal loans are unsecured and often used for various purposes, they might have a more immediate impact on your credit score than an LAMF, which is tied to your investment portfolio.
6. Can I take a Loan Against Mutual Funds for any purpose?
Yes, you can use a Loan Against Mutual Funds for any purpose, including personal expenses, business needs, or education. However, it’s crucial to ensure you have a plan for repaying the loan to avoid affecting your investment.
Conclusion
Choosing between a Loan Against Mutual Funds with a 10.5% interest rate and a Personal Loan with an 11.5% interest rate involves more than just comparing rates. You should consider the implications of collateral, the total cost of borrowing, and your personal risk tolerance. Each loan type has its benefits and drawbacks, and the best choice depends on your financial situation and goals.
If you have any experiences or questions about these types of loans, feel free to share them in the comments below. Making an informed decision can help you manage your finances more effectively and align your borrowing choices with your long-term financial strategy.