Why Salaried Professionals Prefer Loan Against Mutual Funds

A loan against mutual fund is a loan taken by a mutual fund investor, where by he/she gives his/her mutual fund units as security. They do this without using up the units that they redeemed. The lender approves a loan based on the value of the units pledged and the investor retains the underlying investment and pays back the loan.

This is useful for salaried individuals as it offers a way to access cash for short-term requirements such as medical expenses, down payments, or when experiencing a cash flow gap. They can do so without altering a longer-term investment strategy or forcing a premature withdrawal of stocks from mutual funds.

What is a loan against mutual funds?

A loan against mutual funds is a secured loan where mutual fund units, equity or debt, are pledged with a lender as collateral. Instead of selling the units to raise cash, the investor pledges them, and the lender releases funds up to a percentage of the units’ value.

The ownership of the mutual fund units does not transfer to the lender. The units remain in the investor’s demat account or folio, marked as pledged. They are released once the loan is fully repaid.

Why Salaried Professionals Find this Useful

Salaried professionals often build their mutual fund portfolios over several years through SIPs. Redeeming these investments too early can interfere with long-term financial goals like retirement or a child’s education.

• Access funds without interrupting a SIP-linked investment plan.
• Avoid capital gains tax that applies to the redemption of units.
• Stay invested and benefit from potential future growth of the pledged units.
• Use the loan for planned or unexpected short-term expenses.
• Experience typically faster processing than unsecured loan options since the loan is backed by collateral.

Features of loan against mutual funds

• Offered against equity mutual funds, debt mutual funds, and hybrid schemes (as per the list of the lender)
• The amount of loan is proportional to the market worth and type of the units pledged.
• Units are maintained in the same manner as dividends and growth are paid during the pledging period, subject to the terms and conditions of the lender.
• Can generally be accessed online, as mutual fund units are available in either demat or statement-of-account form
• May offer overdraft/drawdown facilities, charging interest on only the amount used

Benefits of choosing this route over redemption

Comparing borrowing against mutual funds with selling them helps illustrate the practical difference for a salaried investor.

Eligibility for loan against mutual funds

Eligibility is primarily determined by the type, category, and value of the mutual fund units being pledged, along with the lender’s standard borrower checks.

• Units should be held in the borrower’s own name, in a recognised demat account or registrar statement.
• The mutual fund scheme should feature on the lender’s approved list of eligible securities.
• Applicant should meet the lender’s standard KYC and creditworthiness requirements.
• Minimum and maximum loan amounts vary by lender and are specified in the loan terms.

Loan Process

The process for availing a loan against mutual funds is generally straightforward, since it relies on existing investment records rather than fresh collateral valuation in most cases.

1. Check the list of eligible mutual fund schemes and the applicable loan-to-value with the lender
2. Submit an application along with KYC documents and mutual fund holding details
3. Pledge the selected units in favour of the lender through the depository or registrar
4. The lender verifies the pledge and sanctions the loan amount based on eligible value
5. Funds are disbursed, typically to the borrower’s bank account or as an overdraft limit

Loan-to-Value (LTV) for Mutual Funds

Loan-to-value is the amount of the loan relative to the value of the units being pledged. This percentage varies depending upon the scheme category as equity and debt mutual funds are of different market risk.

While LTV determines the maximum borrowing limit, the loan against mutual fund interest rate determines the overall borrowing cost. Before applying, borrowers should compare both the applicable LTV and the loan against mutual fund interest rates offered by different lenders to make an informed financial decision.

Interest and Repayment

Interest on a loan against mutual funds is usually charged on the amount actually utilised, particularly where the facility is structured as an overdraft. Repayment structures can include interest-only servicing with principal repayment at tenure end, or structured EMIs, depending on the lender.

Applicable interest rates, processing fees, and other charges vary by lender and market conditions. For current, accurate figures, borrowers should refer to the official interest rate and fee schedule rather than relying on generic estimates.

Risks and Considerations

• A fall in the market value of pledged units can trigger a margin call, requiring the borrower to pledge additional units or repay part of the loan
• Failure to meet a margin call as per the lender’s terms can result in the lender selling the pledged units to recover the outstanding amount
• The loan is not risk-free, and market-linked investments used as collateral can fluctuate in value
• Borrowers should assess repayment capacity before pledging investments meant for long-term goals.

Conclusion

A loan against mutual funds option enables the salaried class to avail short-term financial requirements without disturbing the long-term investment plan. It is best suited for individuals who already have a portfolio of mutual funds, have a solid plan to repay and are simply looking for short-term liquidity and not additional debt.

Before applying, it is advisable to review the eligible fund list, applicable loan-to-value, and current interest rates on the lender’s official pages to make an informed decision.

FAQs

Can I get a loan against any mutual fund I hold?

Only mutual fund schemes on the lender’s approved list of eligible securities can typically be pledged. It’s best to check this list before applying.

Do I lose ownership of my mutual fund units when I pledge them?

No. Ownership remains with the investor; the units are marked as pledged and are released once the loan is fully repaid.

Is interest charged on the full sanctioned amount or only the amount used?

This depends on the loan structure. Overdraft-style facilities usually charge interest only on the amount utilised, while term loans may charge interest on the full disbursed amount.

What happens if the value of my pledged mutual funds falls?

A significant fall in value can trigger a margin call, where the borrower is asked to pledge additional units or repay part of the loan to restore the required loan-to-value.

How is this different from redeeming my mutual funds for cash?

Pledging retains your investment and ongoing market exposure, while redemption ends your holding and may attract capital gains tax. A loan involves interest and repayment; redemption does not.