Loan against Mutual Funds: Smart Borrowing or Hidden Risk?
Life doesn’t always give advance notice. A hospital bill, school fees, or urgent home repairs can catch us off guard. In such moments, quick access to funds becomes a priority. Many investors consider selling their mutual fund holdings for cash. But that often disrupts long-term goals and attracts tax implications.
There’s a smarter solution called Loan against Mutual Funds (LAMF), a facility which allows you to raise funds without selling your investments. By pledging your mutual fund units, you retain ownership and continue to earn potential market returns. More importantly, you avoid triggering capital gains tax.
How it works
Loan against mutual funds is a form of secured lending. You pledge your mutual fund units (equity or debt) as collateral. The loan amount depends on the Net Asset Value (NAV) and the fund type. Generally, you can borrow 50–60% of the NAV for equity funds and 80–90% for debt funds.
The final eligibility depends on the fund’s liquidity, volatility, and past performance. Equity funds, being more volatile, usually attract lower loan-to-value (LTV) ratios than debt funds.
Once the loan is sanctioned, the pledged units continue to stay invested. You benefit from any market upside unless you default. Many banks have digitised the process, offering faster approvals and minimal paperwork.
How lenders assess your eligibility
Lenders look at several factors before sanctioning a loan:
- Type of fund: Equity funds are riskier, so loan-to-value (LTV) ratios are lower.
- Fund performance and NAV: The NAV at the time of pledging determines the loan quantum.
- Volatility and liquidity: Highly volatile funds attract more conservative LTV.
- Borrower profile: Your credit score, age, income, and KYC compliance are assessed.
- Mode of holding: Units must be held in demat or electronic form.
Based on this, the bank decides the loan amount, interest rate, and tenure. Riskier funds or poor credit scores will likely mean tighter terms.
Benefits
The biggest benefit of LAMF is liquidity without liquidation. You get access to cash while your investments remain intact and continue to grow. You also avoid premature exit from long-term goals such as buying a house or funding retirement.
There’s no capital gains tax since you’re not selling your units. And because this is a secured loan, the interest rates are generally lower than those on personal loans. Processing is often quicker too, with many banks offering digital applications and flexible repayment options suited to short-term needs
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Personal loan vs loan against mutual funds
The core difference between a personal loan and loan against securities, such as mutual funds, is in collateral and cost. A personal loan is unsecured, easier to access, but lenders charge higher interest rates to offset the risk.
In contrast, loans against securities are secured loans. You pledge your mutual fund units, shares, or bonds. This lowers the lender’s risk and brings down the interest rate, often by a few percentage points. Moreover, you retain ownership of your investments and can benefit from any market upside while tapping into short-term liquidity.
What you must know
Loans against mutual funds aren’t without risks. A market downturn can lower your NAV. That may lead to a margin call, requiring you to top up the collateral, or the lender may sell part of your units. Here are a few rules to consider regarding these loans:
- Borrow only what you can repay.
- Have a repayment plan and avoid borrowing for consumption or speculation.
- Read the fine print to understand the interest rate, tenure, margin requirements, and foreclosure terms.
Loans against mutual funds are best used for short-term needs. Used wisely, they are a great way to unlock liquidity without halting your wealth journey.
Adhil Shetty is the CEO of BankBazaar.com