Loan Against Mutual Fund: When to Take It and When Not

Loan Against Mutual Fund: LAMF is an emerging trend as a substitute to personal loans and gold loans in favor of a loan against mutual funds. The ability of investors to borrow money in real time by putting up their mutual fund units through the digital platforms and fintech companies has made this possible. The option is however convenient but has risks that all investors ought to be aware of.

What Is a Loan Against Mutual Funds?

A mutual fund loan is where you use your current holdings in the MF as security and raise funds without selling your investments. As soon as a loan is paid off, the promised units are returned into your portfolio.

The procedure is entirely online, unlike conventional loans. The fintech platform can know about your mutual fund portfolio by only entering your PAN number in an app, and the application will decide whether you can get a loan depending on the loan-to-value (LTV) ratio.

How Much Loan Can You Get?

• Equity Mutual Funds: Up to 50% of the portfolio value.
• Debt Mutual Funds: Up to 80% of the portfolio value.
• ELSS Funds: Not eligible due to lock-in.

For example, if you have ₹4 lakh in equity MFs, you may get up to ₹2 lakh as a loan. The same ₹4 lakh in debt funds can fetch up to ₹3.2 lakh.

Loan amounts start as low as ₹10,000 and can go up to several crores depending on the portfolio size.

Interest Rates and Charges

One of the biggest advantages of LAMF is its relatively lower cost:

• Interest Rates: 1% to 15% per year, compared to 9%–24% for personal loans.
• Processing Fees: ₹1,999 or 0.5%–1.5% of the loan amount.
• Tenure: Usually 12, 24, or 36 months. Some platforms allow extensions for an extra charge.

Another benefit is repayment flexibility. Borrowers can pay only the interest monthly and close the loan anytime without foreclosure charges by repaying the principal.

Risks of Taking a Loan Against Mutual Funds

While the loan is attractive, there are risks:

1. Market Volatility: If your equity MF value drops, you may need to pledge more units or repay part of the loan.
   • Example: You pledge ₹4 lakh worth of equity funds and take a ₹2 lakh loan. If the market falls 20%, the portfolio drops to ₹3.2 lakh, reducing your loan eligibility. You must either pledge extra units worth ₹40,000 or repay ₹40,000.
2. Forced Sale: If you fail to maintain the required collateral, the lender may sell your pledged units within seven days.
3. No Access to Returns: Dividends or capital gains from pledged units cannot be used until the loan is fully repaid.

When Should You Take a Loan Against Mutual Funds?

• Ideal Situations:
  • Short-term liquidity needs.
  • Emergency expenses without disturbing long-term investments.
  • When the expected MF returns are higher than the loan interest rate.
• Avoid LAMF If:
  • You need money for long-term purposes.
  • Your portfolio is largely equity-based and markets are volatile.
  • Interest outgo may exceed the expected MF returns.

Expert Recommendations

Financial advisors suggest using debt mutual funds for such loans because:

• They allow higher borrowing with fewer units pledged.
• Their values remain relatively stable compared to equity funds.

For long-term requirements, redeeming mutual funds is safer than taking a loan, as interest payments can outweigh the investment returns.

Key Takeaways

Loan against fund is an intelligent and low interest method of addressing immediate funds without selling the investments. Nevertheless, investors should remember to beware of market risks and apply this option only to the case when it is possible to pay off in a short term. In case of a long-term need, it is best to redem compensate.