Borrowing against mutual funds allows investors to unlock liquidity without selling their investments. By using the funds as security, one can obtain a loan for the required period and still be able to keep their investments. The blog further explains the working of a loan against mutual funds, its procedure, advantages, and key considerations, helping readers understand the essentials of this borrowing option. Read now!
What is Loan Against Mutual Funds?
A loan against mutual funds is an option for investors to access the money required without the need to sell their mutual fund units. By pledging the units to the lender, who in return issues the loan, the investor retains ownership of the fund but cannot redeem it until the loan is fully repaid. The sanctioned loan amount is usually a percentage of the fund’s current value, with variations depending on whether it is an equity or debt scheme. Such a facility can be used for financial provisions for a short period, though it is subject to repayment terms and market fluctuations.
What Is a Loan Against Mutual Funds?
At its core, a loan against mutual funds works much like an overdraft facility secured by investments. Once approved, the lender allows borrowers to draw funds as needed, paying interest only on the utilised amount in some cases. This can be more cost-effective than liquidating investments or opting for unsecured loans. The repayment of the loan can be made in instalments or as a lump sum after which the lien is released, and total ownership rights are restored. Unlike redemption, this approach helps preserve long-term investment goals, though it comes with borrowing costs and the risk of margin calls if fund values decline.
How It Works: Collateral & Lien Process
Mutual fund units that have been pledged as security for a loan against mutual funds represent the collateral for the loan. Unlike traditional loans that typically involve physical assets, this process is carried out entirely digitally, making it more user-friendly and faster.
After the sanction of the loan, the lender, in the name of the registrar or the depository,
places a lien on the mutual fund units. This lien is a block that stops the units from being cancelled, sold, or transferred unless the loan is paid off. Moreover, the investor retains ownership of the units during the loan period, meaning the investments can continue generating returns.
As market values fluctuate, the lender keeps track of the worth of these pledged units. If their value drops significantly, the lender may require the borrower to either repay part of the loan or pledge additional units to maintain the required collateral. This safeguard, also called a margin call, helps ensure the loan remains adequately secured, protecting both the lender and the borrower.
For example, suppose an investor pledges mutual fund units worth ₹ 10 lakhs and takes a loan of ₹ 4.5 lakhs, which is 45% of the unit value. If due to market fluctuations, the value of those units falls to ₹ 9.5 lakhs, the eligible loan amount is revised down to ₹ 4.27 lakhs. However, if the borrower has not repaid the loan and the outstanding remains ₹ 4.5 lakhs, the lender will issue a margin call. The borrower will be asked to either repay the difference of ₹ 22,500 or pledge additional units to maintain sufficient collateral. This process protects the lender from the risk of the loan exceeding the collateral’s value.
The lien is removed when the borrower completes the repayment cycle and pays off all the dues. The investor’s control over the investment, which is back in the mutual fund portfolio, is now restored.
Suppose an investor pledges mutual fund units worth Rs. 5 lakhs to get a loan. After fully repaying the loan, the lender requests the mutual fund company to remove the lien on those units. This process usually takes a few days, after which the lien is lifted. Once removed, the investor regains full control over the units and can sell, switch, or redeem them freely without any restrictions.
Loan-to-Value (LTV): Equity vs Debt Funds
The loan-to-value (LTV) ratio determines how much one can borrow against the value of pledged mutual fund units. Since equity and debt funds carry different levels of risk and stability, lenders apply varying LTV percentages to each. The comparison below highlights the key differences:
| Aspect | Equity Funds | Debt Funds |
| Nature of Investment | Linked to stock markets, often subject to sharp price movements | More predictable, with comparatively limited price fluctuations |
| Risk Profile | Considered high risk due to market volatility | Viewed as lower risk because of steadier performance |
| Usual LTV Ratio | Lower, as lenders factor in the chance of sudden disruption in value due to market volatility | Higher, reflecting greater stability of underlying holdings |
| Effect on Loan Amount | Borrowers generally receive a smaller share of current value | Borrowers usually qualify for a larger proportion of value |
| Impact of Value Shifts | Market corrections may reduce borrowing eligibility quickly | Value remains steadier, so the risk of margin calls is reduced |
Benefits of Loans Against Mutual Funds
A loan against mutual funds offers investors a way to access liquidity without immediately selling their investments. The dependability of such a setup is different from one person to another; however, there are some advantages which are generally linked to it:
- Continued Investment Growth: The pledged mutual fund units remain invested, enabling investors to maintain market exposure throughout the loan period.
- Retention of Ownership: Since the units are not sold, investors retain ownership rights of the portfolio.
- Faster Processing: If an investor holds mutual fund units, lenders can approve loans more quickly than many unsecured options.
- Lower Interest Rates: Since the loan is secured against financial assets, lenders often offer interest rates lower than those on unsecured borrowing options.
- No Need for Liquidation: Investors can meet their short-term liquidity needs without disturbing their long-term wealth creation plans.
- Flexible Repayment Options: The lender may allow repayment by instalments or through an overdraft-style facility, where interest is charged only on the utilised amount, depending on the lender.
Risks & Considerations
While a loan against mutual funds can provide liquidity without redeeming investments, recognising the associated potential risks and terms is an important thing to do. The following situations are the most common ones to be considered:
- Dependency on the market: The mutual fund units’ prices will change as the market moves, which in turn can impact the total amount of the loan for which you will be eligible.
- Margin calls: In case the value of the units you have pledged falls a lot, the lender might ask for more security or repayment of a part of the loan.
- Limitations on redemption: Stocks under lien cannot be sold, or their value cannot be repaid, until the loan is fully released.
- Interest costs: Borrowing involves interest payments, which may reduce the financial benefit of using this facility.
- The obligation for repayment: You are still required to make your regular repayments as scheduled, whether the market performs well or you have financial difficulties.
- The chance of forced selling: In case you fail to repay the lender, the lender may dispose of the units you have pledged to recover the funds lent to you.
Process: How to Apply (Online & Offline)
Applying for a loan against a mutual fund can be done through the digital channel or the offline channel. Lenders typically streamline the procedure to make it convenient for investors. The steps explained below generally outline the application process in a given lattice:
Online application
- Go to the website or the mobile app of the lender, after which you select the option of a loan against mutual funds.
- Fill in the basic details such as PAN, mutual fund folio number, and loan requirement.
- Choose those mutual fund units from which you want to borrow against.
- The depository or registrar electronically facilitates the creation of the lien.
- The approved loan amount is, by default, transferred to your bank account after the verification process.
Offline Application
- Visit the branch of the bank or financial institution offering this facility.
- Complete the required forms and submit documents like identification, mutual fund statements, and bank details.
- Specify the mutual fund units to be pledged as collateral.
- The lender initiates the lien marking on the units in coordination with the registrar.
- The funds are released to your account once the approval is made.
Regardless of the paperless digital process or the traditional in-person assistance, the dual application mode offers investors flexibility to select the method that matches their convenience the most.
Comparing Lenders & Digital Options
When applying for a loan against mutual funds, banks, as well as non-banking financial companies (NBFCs), are the two common providers available. While they do provide the same kind of service, there are differences in approach and borrower experience.
- Banks: Usually the most trusted for their credibility and systematic processes. Banks are likely to offer lower interest rates, but the approval period could be longer due to more detailed checks and paperwork being required.
- NBFCs: Generally, they are more relaxed in eligibility criteria and quicker in processing. They may provide you with a slightly higher interest rate than a bank, but the comfort and shorter turnaround time can be very attractive to some borrowers.
Besides banks and NBFCs, digital lending platforms have become very popular. The platforms for these online applications usually require minimal documentation; lien creation is done instantly via depositories, and disbursal is faster. For many investors, the appeal lies in the speed and convenience of managing everything digitally, without visiting a branch.
When you are deciding which one to go for, you should consider factors like interest rates, fees, processing time, repayment flexibility, and digital accessibility. Each route has its own balance of cost and convenience.
Conclusion
A loan against mutual funds provides a means of accessing funds without liquidating investments. Pledging the units as security, investors can not only meet their urgent needs but also keep their portfolio intact. Although the instrument has particular conditions, fees, and risks that must be understood, it is important to view it as a borrowing tool rather than an investment decision.
FAQs
A loan-to-value (LTV) ratio for mutual fund loans represents the percentage of the current market value of pledged mutual fund units that lenders are willing to loan. For equity funds, LTV ratios vary in a range of 40% to 70%, while for debt funds, it may be considerably higher, generally up to 80% to 90%. The exact ratio will depend on the mutual fund type as well as the policies of the lender.
A loan against mutual funds is a facility where investors can avail loans by pledging their mutual fund units as collateral. This makes it possible to get a loan without selling the investments while returns are still being made from the units. The loan is secured, and it is subject to the terms of repayment and the lender’s approval.
By pledging mutual funds, investors have the opportunity to take out money without the need to sell their units, and therefore, they still retain the ownership and the potential returns. This usually goes hand in hand with faster processing and lower interest rates as compared to unsecured loans; thus, investors can still follow their long-term investment plans without any disturbance.
Investors should be aware that market fluctuations can lead to a reduction in the value of their pledged units and, hence, margin calls. They have to meet the interest payment and principal repayment obligations; besides this, there is a risk of forced selling of units if the loan is not repaid within the due date.
One can use the website of the lender or the mobile app to submit applications along with the necessary details and pledge mutual fund units electronically. On the other hand, investors can apply offline by going to a branch and filling out the paperwork with the necessary documents for creating a lien.
Not all mutual fund schemes qualify for loans. Lenders generally accept funds in equity, debt, or hybrid instruments that are registered with recognised registrars. The eligibility of the scheme depends on the risk profile and liquidity, and each lender has a specific list of mutual fund schemes approved.
Some banks that provide loans against mutual funds in digital mode are ICICI Bank, HDFC Bank and South Indian Bank. Such loans allow a quick, paperless procedure with instant marking of lien and easy fund disbursal, thus giving the cash alternative to the investors without having to sell their investments.
