A loan against mutual funds is a secured loan where individuals pledge their mutual fund units as collateral to obtain short-term credit.
New Delhi [India], May 19: In moments of financial urgency, many investors instinctively turn to their mutual fund investments for immediate liquidity. While redeeming fund units might provide a quick solution, it often disrupts long-term investment plans and incurs tax liabilities. A more strategic and less intrusive alternative is opting for a loan against mutual funds. This financial facility allows investors to borrow against their mutual fund holdings without selling them, thereby preserving both the growth potential and tax advantages of their portfolio. This article explores how such loans work, their benefits, eligibility conditions, and practical use cases.
What is a loan against mutual funds?
A loan against mutual funds is a secured loan where individuals pledge their mutual fund units as collateral to obtain short-term credit. The borrower continues to remain the owner of the mutual fund units, but they are temporarily placed under lien in favour of the lender. The lien restricts the investor from redeeming the units until the loan is repaid in full. These loans can be availed against both equity-oriented and debt-oriented mutual funds. Financial institutions usually offer these loans either as term loans or overdraft facilities.
How the loan process works
The mechanism for availing a loan against mutual funds is relatively simple. Most modern lenders now offer fully digital processing, which makes the entire transaction faster and more convenient. Here is how it works:
- The investor initiates the loan application through the lender’s website or mobile app
- The investor provides consent to mark a lien on specific mutual fund units via CAMS or KFintech
- Upon successful lien marking, the lender disburses the loan to the investor’s bank account
- The borrower can repay the loan in instalments or make lump sum payments, depending on the loan terms
- On full repayment, the lien is removed, and the mutual fund units are restored to the investor’s full control
Key eligibility criteria
To be eligible for a loan against mutual funds, the applicant must meet the following general criteria:
- Be a resident Indian individual aged 18 years or above
- Hold mutual fund units in dematerialised form or registered under CAMS or KFintech
- Provide basic KYC documents such as PAN card, Aadhaar card, and bank details
- Some lenders may request proof of income or employment depending on the loan amount and profile
This loan facility is typically not extended to NRIs, minors, or those who do not meet the minimum fund holding requirements.
Interest rates and the loan against mutual funds interest rate structure
The Loan Against Mutual Funds Interest Rate is generally lower compared to unsecured forms of credit such as personal loans or credit cards. Since mutual fund units are pledged as collateral, lenders face less risk and therefore offer more competitive rates. Typically:
- Debt mutual funds attract interest rates ranging from 8 percent to 11 percent
- Equity mutual funds carry slightly higher rates, generally between 10 percent and 13 percent
In addition to interest, borrowers may incur the following charges:
- Processing fees: Usually between 0.5 percent and 2 percent of the loan amount
- Documentation charges: Often around Rs. 500 to Rs. 1,000
- Penal interest: Applied in case of delayed repayments or non-compliance with loan terms
The interest may be charged on a reducing balance basis or only on the amount drawn, especially in overdraft-linked facilities, making it a more flexible and cost-effective borrowing solution.
Loan-to-value (LTV) ratio
The loan-to-value ratio determines the maximum amount that can be borrowed against the pledged mutual fund units. The percentage varies based on the fund category:
- Equity mutual funds: LTV ranges from 50 percent to 60 percent
- Debt mutual funds: LTV can be up to 70 percent or higher
For example, if an investor pledges Rs. 5 lakh in equity mutual funds, they may be eligible for a loan of Rs. 2.5 lakh to Rs. 3 lakh. In contrast, the same amount in debt funds may secure a loan of up to Rs. 3.5 lakh. It is important to remember that lenders may revise the LTV if the value of the mutual fund units fluctuates due to market conditions.
Benefits over mutual fund redemption
Choosing a loan over redemption provides several advantages:
- Preservation of investment: Investors do not interrupt their long-term financial goals or exit the market prematurely
- Avoidance of capital gains tax: Loans do not attract capital gains tax since the units are not sold
- Quick disbursal: Loan approval and disbursal can happen within 24 to 48 hours
- Lower interest rates: Compared to credit cards or personal loans, LAMFs offer a more economical borrowing solution
- Flexible repayment options: Borrowers can repay through EMIs or on-demand in case of overdraft facilities
Common use cases
Loans against mutual funds can be extremely helpful in various real-life scenarios:
- Managing emergency medical expenses
- Funding short-term business needs or working capital
- Paying education fees or examination costs
- Handling temporary cash flow issues without disturbing long-term investments
- Taking advantage of other investment opportunities without liquidating current ones
Taxation aspects
One of the notable advantages of a loan against mutual funds is its tax efficiency. Since no sale of units is involved, investors are not liable to pay capital gains tax. However, if the borrower defaults and the lender sells the units to recover the dues, then the applicable capital gains tax will be levied based on the type of mutual fund and the holding period. Furthermore, the interest paid on the loan is not eligible for tax deduction unless the funds are used for business purposes and proper records are maintained.
Factors to evaluate before taking a loan
Although loans against mutual funds offer convenience, investors should take the following factors into account:
- Purpose of the loan: Use the facility only for essential or short-term needs
- Loan amount vs. fund value: Ensure that the loan does not exceed prudent limits compared to total holdings
- Fund type: Debt funds are more stable and preferable for pledging
- Repayment discipline: Ensure the ability to repay to avoid potential asset liquidation
- Market volatility: Consider the risk of value erosion and the possibility of a margin call
Evaluating these aspects in advance will ensure that the loan remains a helpful tool rather than a financial burden.
Final thoughts
A loan against mutual funds is a wise financial strategy for those seeking liquidity without undermining their investment goals. It enables individuals to bridge short-term financial gaps, retain long-term market exposure, and optimise tax efficiency. Instead of redeeming mutual fund units in haste, especially during a market downturn, investors can preserve their portfolio’s value and growth potential by opting for this smarter alternative. With digital access, competitive interest rates, and minimal paperwork, LAMFs are emerging as a preferred financial solution for the informed investor.