That said, loans against mutual funds carry risks. Because what you pledge as collateral is a volatile asset class—equity funds, particularly, can go through volatile phases during market turbulence. If you fail to maintain the required margin, you may be forced to part with your investments.
We look at how fintech platforms enable quick access to loans against mutual funds and why you should be cautious when availing them.
Quick access
So, if you have a fintech app that offers loan options such as a loan against mutual funds, all you will need to do is submit your PAN number on the platform’s app. The app automatically fetches the borrower’s fund holdings linked to that PAN. Based on the platform’s loan-to-value ratio and its list of eligible schemes, the credit limit is calculated. The borrower can then choose to either go with the same credit limit or set a lower limit.
So, if you have a fintech app that offers loan options such as a loan against mutual funds, all you will need to do is submit your PAN number on the platform’s app. The app automatically fetches the borrower’s fund holdings linked to that PAN. Based on the platform’s loan-to-value ratio and its list of eligible schemes, the credit limit is calculated. The borrower can then choose to either go with the same credit limit or set a lower limit.
Most platforms have a minimum loan amount, often in the range of ₹10,000-25,000, while the upper cap can run into a few crores depending on the borrower’s portfolio size. The loan-to-value (LTV) ratio tells you how much you can borrow for each type of loan.
The borrower can also adjust the credit limit at the scheme level by selecting how many units of a particular scheme to pledge. The credit limit acts as an overdraft facility; you are charged interest on the amount you withdraw from this facility. Debt mutual funds offer a higher LTV ratio. More on that later. But remember, you cannot sell the pledged mutual funds until you fully repay the loan.
The next step is to link your bank account. This account will receive the loan amount and be used to set up an auto-debit mandate for monthly interest payments. The mandate becomes active after loan disbursal.
After linking your account, you need to pledge your mutual fund units, which you can do by simply entering the OTP sent to your registered mobile number. Once the pledge is confirmed, a digital loan agreement pops up, which you can review and sign digitally to complete the application.
“As it is a fully digital process, the loan can be availed almost instantly,” said Krishna Kanhaiya, chief executive officer of Mirae Asset Financial Services. Digital platforms take minutes to a few hours to disburse the loan into the borrower’s bank account.
With certain caps, the loan processing fee is ₹999 or 0.5-1.5% of the loan amount. The loan tenure is 12 months, 24 months or 36 months, depending on the platform. At the end of the loan tenure, borrowers who wish to extend the facility must pay a renewal fee—usually equal to the original processing fee—before the loan can be rolled over. The processing fee for a personal loan ranges from 1% to 3% of the loan amount.
Cost of borrowing
Each platform maintains its own internal list of mutual funds eligible for loans. The LTV ratio depends on the type of fund. Typically, equity mutual funds allow you to borrow up to 50% of their value, while debt funds can fetch as much as 80%.
For example, if you hold equity mutual fund units worth ₹4 lakh, you can borrow up to ₹2 lakh against them. On the other hand, if you have debt mutual fund units worth ₹4 lakh, the loan eligibility could go up to ₹3.2 lakh, given the higher LTV offered on debt schemes.
The cost of borrowing is another draw. While personal loans often carry interest rates of 9-24% per annum, loans against mutual funds are usually available at 9-15%, depending on the lender and fund type. Repayment is also more flexible—you typically need to service the monthly interest. You can partially prepay the principal by making a lump-sum credit to the overdraft facility, but before the loan tenure, you need to repay the entire principal or roll over the loan by renewing the tenure. Many platforms also allow prepayment without any foreclosure charges.
“Since the borrower provides collateral, the loan will likely get extended even if the borrower’s credit score is low. However, if there has been a history of default on repaying loans, then the application might get rejected,” pointed out Adhil Shetty, chief executive officer of Bankbazaar.
However, you need to be cautious. If you borrow against equity mutual funds, you must pledge investments worth at least 50% of the loan amount as margin. The challenge arises during periods of high market volatility, when the value of your pledged equity holdings can decline rapidly. In such cases, the lender may issue a margin call—asking you to provide additional collateral by pledging more units, or allowing them to liquidate part of your investments to restore the required margin.
For instance, suppose you pledge ₹4 lakh worth of equity mutual funds to avail a loan of ₹2 lakh. If markets correct by 20%, the value of your pledged funds falls to ₹3.2 lakh. Since the lender needs to maintain at least 50% of the loan amount as margin, the cushion has now shrunk to ₹1.6 lakh. So, there is now a shortfall of ₹40,000. To protect themselves, the lender can issue a margin call—asking you to pledge more units to restore the buffer by paying ₹40,000. If you cannot do either, the lender can sell part of your pledged investments to bring the margin back in line.
Any restrictions?
You continue to receive all the benefits—like dividends and capital appreciation—from the mutual funds you pledge. The only restriction is that these units cannot be sold or redeemed until the borrower clears the outstanding loan.
The borrower can keep adding to the same fund through lump sum investments or systematic investment plans (SIPs), even while some of the holdings remain pledged.
You cannot pledge locked-in units, such as those in equity-linked saving schemes (ELSS), during their mandatory three-year lock-in period. Some platforms let you pledge the remaining free units, those that have completed the lock-in period, as collateral.
When should you opt for it
You may be borrowing at a cheaper rate, but the trade-off is the impact on your investments, which needs to be weighed very seriously. If you need funding for the short term, a loan against a mutual fund is a better alternative than selling your mutual fund investments and losing on their long-term compounding potential. However, you can even lose your investments if you cannot restore your margin during volatile markets.
“We advise clients when they have a short-term funding need to consider this type of loan, but we prefer they take the loan against debt mutual funds, where they can get a higher LTV, and the volatility of the collateral is on the lower side. This reduces frequent margin calls and pressure to pledge more units or repay to reduce the loan amount,” said Vishal Dhawan, founder of Plan Ahead Wealth Advisors.
While planners may be okay for short-term funding needs, long-term funding through mutual funds is a strict no-no. “But if you need funding for a longer term, debt mutual funds are not ideal, as the interest rate is likely to be higher than the yield on such funds. In such scenarios, it may be better to redeem the debt fund rather than take a high-interest loan against it,” said Surya Bhatia, financial adviser at Asset Managers.
If a borrower only has equity-oriented funds, it is prudent not to maximise the LTV ratio and keep some room for market volatility. Remember, if you fail to bring the LTV back within limits within seven days, the platform has the right to sell your mutual fund units to adjust the outstanding loan.
Use the option sparingly despite the limits, allowing you 80% LTV in a debt mutual fund and 50% in the case of an equity mutual fund. You shouldn’t pledge more than 30-50% of your mutual fund investments for such loans, especially if you have linked these funds to your long-term goals.
Bottomline: While a loan against a mutual fund may seem like a quick and cheaper alternative, use the option wisely, or you might risk eroding the very wealth you are trying to protect.