Mutual funds have long been recognised as a reliable investment tool for building wealth over time. However, they are not just limited to helping you grow your savings. Mutual fund investments can also
be used to access short-term liquidity without having to redeem them. This is made possible through a facility known as a loan against mutual funds. Similar to a loan against fixed deposit, this secured credit line allows you to pledge your mutual fund units as collateral and borrow funds when needed.
What is a loan against mutual funds?
A loan against mutual funds allows you to borrow money from a lender by pledging your mutual fund units as security. You continue to hold the ownership of your mutual fund investments, which means they remain invested and continue to generate returns. The lender only marks a lien on the pledged units, preventing you from redeeming them during the loan tenure. Once the loan is repaid in full, the lien is removed, and your mutual fund units are released.
The loan amount sanctioned depends on the value of your holdings and the lender’s policies. For equity mutual funds, the loan-to-value ratio typically stands at around fifty percent, while for debt mutual funds, it can go up to seventy to eighty percent due to their relatively stable nature. This type of loan is ideal for investors looking for short-term liquidity without interrupting their investment journey.
Features of loan against mutual funds
A loan against mutual funds is considered a secured, short-term credit facility. The loan tenure generally extends up to twelve months, although renewal options may be offered by certain financial institutions. Loan amounts usually range between twenty-five thousand rupees and five crore rupees, based on the net asset value of the pledged mutual fund units and the internal criteria of the lender.
Both equity and debt mutual funds are eligible for pledging, but the exact acceptance depends on the type of fund and the risk it carries. For equity funds, lenders typically allow up to fifty percent of the fund value as the loan amount. For debt funds, this limit can go up to seventy or eighty percent.
The disbursal process is often quick, with the loan amount credited within twenty-four to forty-eight hours of application, especially when processed via digital platforms that integrate with registrar services like CAMS or KFintech.
Throughout the loan tenure, you continue to retain ownership of your pledged mutual fund units. These units remain invested in the market, which means they can still appreciate in value and generate potential returns, even while being used as collateral.
Comparison with loan against fixed deposit
While a loan against mutual funds is an attractive option, it is often compared with the more traditional loan against fixed deposit. Both facilities are secured in nature and offer quick access to liquidity, but they differ in key areas.
A loan against fixed deposit generally offers a higher loan-to-value ratio, often up to ninety or ninety-five percent of the deposit amount. Since fixed deposits are non-market linked and carry guaranteed returns, the risk to the lender is minimal. As a result, the interest rate charged on loans against fixed deposits is usually one to two percent higher than the interest rate earned on the deposit itself.
In contrast, mutual fund loans carry a slightly higher interest rate, typically ranging between nine percent and twelve and a half percent per annum. This is because mutual fund values fluctuate with market performance, making them relatively riskier as collateral.
However, mutual fund loans offer the benefit of keeping your long-term investment goals intact, especially during a market dip. Instead of redeeming your mutual fund units at a low NAV, you can pledge them and access funds while waiting for the market to recover.
Why mutual funds make effective collateral
Using mutual funds as collateral helps you meet immediate financial needs without compromising your long-term savings plan. If you redeem your mutual funds, you may incur capital gains tax and possibly miss out on future returns if the market recovers after your withdrawal. A loan against mutual funds helps you avoid both scenarios.
Interest rates on mutual fund loans are competitive and significantly lower than unsecured borrowing options such as personal loans or credit cards. Furthermore, many fintech lenders now offer digital application and approval processes, making it easier and faster to access such loans.
Another key benefit is that your mutual fund units remain invested. This means they can continue to appreciate over time or provide dividend income if you hold income distribution schemes. The flexibility to repay in lump sum or through structured interest payments also adds to its convenience.
Key factors to keep in mind
Before opting for a loan against mutual funds, it is important to evaluate a few factors. Market volatility can impact the NAV of your pledged units. If the value falls significantly, the lender may issue a margin call, requiring you to either pledge additional units or repay part of the loan. Failure to do so may result in liquidation of some or all pledged units by the lender.
Also, while some lenders charge minimal processing fees, others may have higher fees or prepayment penalties. Make sure to compare the terms across lenders and choose one that offers flexibility and transparency.
Ensure that you do not over-leverage your portfolio. It is wise to pledge only the portion of your mutual fund holdings that you are confident you will be able to repay within the loan tenure.
When should you consider a mutual fund loan?
A loan against mutual funds is best suited for short-term requirements such as emergency medical expenses, educational costs, business working capital, or any unforeseen financial need. It is also a smart alternative during a market downturn when redeeming your mutual fund units may not be ideal.
If you are confident in your repayment ability and want to avoid selling long-term investments, this facility provides a practical and efficient way to raise funds without disturbing your financial strategy.
Conclusion
A loan against mutual funds unlocks a powerful use of your existing investments. It combines the advantage of preserving your wealth-building assets with the ability to access liquidity when needed. While a loan against fixed deposit may offer slightly lower interest rates and higher loan-to-value ratios, mutual fund loans offer flexibility and the added benefit of continued participation in market growth.
As with any financial decision, it is important to compare options, understand the risks involved, and align your borrowing with your repayment capacity. When used wisely, a loan against mutual funds can be a valuable tool in managing cash flow while staying invested for the long term.
