5 Things to Know About Loans Against Mutual Fund Investments

A loan against mutual funds is a form of secured lending that allows you to access short-term liquidity without redeeming your mutual fund investments. It is becoming an increasingly popular choice for investors who want to meet urgent financial requirements while keeping their long-term investment goals intact. Here are five important aspects you should know before considering a loan against mutual funds.

1. Understanding how a loan against mutual funds works

A loan against mutual funds operates much like a loan against shares or fixed deposits. When you apply for this facility, your mutual fund units are pledged as collateral in favour of the lender. In return, the financial institution disburses a loan amount, usually as a fixed percentage of the Net Asset Value (NAV) of the pledged units.

This arrangement allows you to raise funds without liquidating your investment. Your portfolio continues to earn returns while being used as a security for the loan. However, you lose access to redeem or switch the pledged units until the loan is repaid in full.

2. The types of mutual fund units accepted as collateral

Not all mutual funds are eligible for pledging. Lenders typically accept:

• Equity mutual funds - Though more volatile, they are commonly pledged due to their popularity.
  
  
• Debt mutual funds - These are considered relatively stable and are preferred by some lenders.
  
  
• Hybrid mutual funds - Only specific types of hybrid funds are eligible, depending on their asset allocation.

The final list of acceptable funds may vary across lending institutions. Generally, schemes from AMCs registered with SEBI and listed on recognised depositories like NSDL or CDSL are accepted.

Additionally, the fund must be held in demat form. Mutual fund units in physical format or those not registered with the appropriate depository are not eligible for this facility.

3. Loan against mutual funds interest rate and charges

The loan against mutual funds interest rate varies by lender and the type of funds pledged. Typically, the interest rates fall within the range of 9% to 12.5% per annum. Loans secured against debt mutual funds may attract lower rates than those against equity mutual funds due to lower market volatility.

Some key cost components to be aware of include:

• Interest rate: Charged either on a monthly reducing balance or daily usage, depending on the lender's terms.
  
  
• Processing fees: Usually around 25% to 1% of the sanctioned amount, with a minimum threshold.
  
  
• Pledge charges: Custodians and depositories like NSDL/CDSL may levy a fee for pledging and unpledging units.
  
  
• Penal charges: Late EMI payments or failure to maintain margin requirements can invite penalty interest.

Since the loan against mutual funds interest rate directly impacts your total borrowing cost, it is advisable to compare multiple lenders and evaluate their terms before availing of the facility.

4. Loan limits, tenure, and margin requirements

The sanctioned loan amount is determined based on the value of the pledged mutual fund units and the lender's loan-to-value (LTV) ratio policy. Generally:

• LTV ratio: Can range from 50% to 70% of the current NAV.
  
  
• Minimum loan amount: Often starts from ₹25,000 or ₹50,000.
  
  
• Maximum loan amount: Can go up to ₹5 crore or more for high-net-worth individuals.
  
  
• Loan tenure: Ranges from one month to three years, depending on the lender.

Lenders may also impose a margin maintenance requirement. If the NAV of the pledged mutual funds falls sharply, the borrower may need to top up the collateral or repay a part of the loan to maintain the margin. Failure to do so may result in the lender invoking the pledged units to recover the dues.

5. Key benefits and considerations before applying

A loan against mutual funds offers multiple advantages, particularly for investors with a long-term horizon. However, it is important to weigh the pros and cons carefully.

Benefits

• No need to redeem investments: Your portfolio continues to grow as per market conditions while serving as collateral.
  
  
• Quick disbursal: Once your mutual fund units are pledged, loans are often sanctioned and credited within 24-48 hours.
  
  
• Lower interest cost: Compared to personal loans or credit card borrowing, a loan against mutual funds generally has a lower interest burden.
  
  
• Flexible usage: The loan can be used for any personal or professional financial need without end-use restrictions.
  
  
• Overdraft option: Some lenders offer an overdraft facility against mutual funds, enabling you to pay interest only on the utilised amount.

Considerations

• Market risk: NAV fluctuations can impact the loan value and may lead to margin calls.
  
  
• Eligibility limitations: Not all mutual funds are accepted, and units must be held in dematerialised format.
  
  
• Loss of liquidity: Pledged units cannot be switched, redeemed, or used for other purposes.
  
  
• Pledge revocation: If repayment obligations are not met, the lender can sell your mutual fund units to recover dues.

Who should consider a loan against mutual funds?

A loan against mutual funds is suitable for:

• Salaried professionals and business owners needing temporary cash flow support
  
  
• Investors seeking emergency liquidity without exiting the market
  
  
• Individuals with long-term investment goals who do not want to disturb compounding
  
  
• Borrowers who want to avoid higher-interest personal loans or credit card debt

However, it may not be ideal for those with highly volatile equity portfolios or individuals with irregular repayment capacity. In such cases, the risk of forced liquidation or margin calls increases.

How to apply for a loan against mutual funds

Applying for a loan against mutual funds is relatively simple. Here is a step-by-step guide:

1. Check eligibility: Confirm if your mutual fund units are accepted and are held in demat form.
   
   
2. Choose a lender: Compare interest rates, tenure, LTV ratio, and processing fees across banks and NBFCs.
   
   
3. Online or offline application: Fill out the application form and provide KYC documents.
   
   
4. Pledge units: Authorise the pledge of units via NSDL/CDSL using your demat credentials.
   
   
5. Loan disbursal: Once the pledge is approved, the loan amount is credited to your bank account.

Some banks and brokers offer fully digital journeys for LAS (Loan Against Securities) including e-signature and digital pledge confirmation.

Conclusion

A loan against mutual funds is a flexible and efficient financing option for investors who require short-term liquidity without disturbing their long-term wealth creation journey. By pledging existing investments instead of redeeming them, you can meet urgent financial needs while allowing your funds to continue earning returns.

However, it is crucial to evaluate the loan against mutual funds interest rate, margin requirements, and risks related to market volatility before proceeding. This facility is most effective when used with financial discipline and a clear repayment plan. For investors with stable mutual fund portfolios and a need for immediate funds, this form of secured borrowing can serve as a practical and cost-effective alternative to traditional personal loans.