Mutual funds are often seen as long-term investment tools, helping individuals build wealth over time. But did you know that your mutual fund portfolio can also serve as a financial safety net during emergencies? Instead of redeeming your investments when in need of urgent cash, you can borrow money by pledging your mutual fund units.
Let’s explore what a loan against mutual funds entails, who is eligible, its benefits, and the potential risks involved.
What Is a Loan Against Mutual Funds?
A Loan Against Mutual Funds is a type of secured loan where you pledge your mutual fund units as collateral to avail a credit facility. Banks and NBFCs (Non-Banking Financial Companies) offer this option, typically as an overdraft or term loan.
You retain ownership of your investments while getting the liquidity you need. It’s a smart way to meet short-term financial needs without interrupting your long-term wealth creation goals.
Eligibility for a Loan Against Mutual Funds
The eligibility criteria may vary slightly depending on the lender, but here are the general requirements:
- Age: You must be at least 18 years old.
- Mutual Fund Type: Both debt and equity mutual funds are usually accepted. However, some lenders prefer liquid or large-cap funds due to their stability.
- KYC Compliance: Your mutual fund folio should be KYC-compliant.
- Account Holder: The loan applicant must be the sole or joint holder of the mutual fund units.
- Minimum Value: Most lenders require a minimum fund value (e.g., ₹25,000 or ₹50,000) to offer a loan.
Note: Loans are generally not available against ELSS (Equity Linked Savings Scheme) due to the 3-year lock-in period.
Key Benefits of Loan Against Mutual Funds
1. Quick Access to Funds
Since it’s a secured loan, the processing is faster with minimal documentation. Many lenders offer instant or same-day disbursal, especially if your funds are held in demat form.
2. Lower Interest Rates
Compared to personal loans or credit cards, the interest rates are relatively lower—usually ranging between 8% to 12% p.a., depending on the lender and fund type.
3. No Need to Liquidate Investments
You don’t have to sell your mutual fund units, which means your investments continue to earn returns and stay aligned with your financial goals.
4. Pay Interest Only on Used Amount
If availed as an overdraft facility, interest is charged only on the amount you utilize, not the entire sanctioned limit.
5. Flexible Repayment
You can repay the loan as per your convenience, and most lenders offer prepayment without penalty.
Risks and Considerations
While LAMF offers several advantages, it’s essential to be aware of the risks:
1. Market Volatility
The value of your mutual funds may fluctuate. If the NAV (Net Asset Value) drops significantly, the lender may ask you to pledge more units or partially repay the loan.
2. Loan-to-Value Ratio (LTV)
Typically, lenders offer up to 50-70% of the fund’s current value as a loan. This margin protects them from market volatility but limits your borrowing capacity.
3. Potential Fund Freezing
The pledged units are locked, meaning you can’t redeem or switch them during the loan tenure unless the loan is repaid.
4. Penalty for Default
Defaulting on repayments can lead to liquidation of your mutual fund units by the lender, possibly at a loss if markets are down.
When Should You Consider a Loan Against Mutual Funds?
- To meet short-term liquidity needs
- During emergencies (medical, business, education)
- When you don’t want to redeem investments prematurely
- If you’re looking for a lower-interest alternative to personal loans
Conclusion
A Loan Against Mutual Funds is a smart financial tool when used responsibly. It offers liquidity without disrupting your long-term investment plans, and comes with competitive interest rates and flexible repayment options.
However, it’s crucial to assess your repayment capacity and be mindful of market risks. If used wisely, this facility can bridge your short-term financial gaps without derailing your future goals.