Loan Against Mutual Funds: Unlocking Liquidity While Staying Invested

Mutual funds are a popular investment option, offering liquidity,  diversification, and the potential for significant returns. However, selling mutual fund units during financial emergencies can disrupt your investment strategy and long-term goals. Instead of liquidating, an alternative is to take a loan against your mutual fund holdings.

What is a Loan Against Mutual Funds?

A loan against mutual funds (LAMF) is a secured loan where your mutual fund units act as collateral. Financial institutions or Non-Banking Financial Companies (NBFCs) provide this facility, allowing you to borrow up to 50–80% of the Net Asset Value (NAV) of your pledged units. The loan amount and interest rates depend on factors like fund type, current NAV, and the lender’s terms.

According to a recent report by CRISIL (formerly Credit Rating Information Services of India Limited), the adoption of LAMF has grown by 25% in 2023 due to increased awareness and ease of availing such loans digitally. With over 15 crore mutual fund folios in India as of October 2024 (AMFI data), this facility is becoming a practical choice for investors seeking liquidity without disrupting their portfolios.

How Does It Work?

1. Eligibility: Most equity, debt and hybrid mutual funds are eligible for pledging.

2. Application Process: Investors apply for the loan online or offline by providing details of their mutual fund holdings.

3. Loan Amount: Based on the NAV and type of mutual fund, lenders sanction a percentage as a loan. For example, equity funds might fetch up to 50% of the NAV, while debt funds could offer up to 80%.

4. Repayment: Borrowers repay the principal and interest over a fixed tenure. During this period, the mutual fund units remain locked but continue to earn returns.

Advantages of Taking a Loan Against Mutual Funds

1. Liquidity Without Selling Investments

When you take a loan against your mutual funds, you maintain ownership of your units, allowing your investments to grow. This option ensures that long-term financial goals, like wealth creation or retirement savings, remain unaffected.

2. Lower Interest Rates

Since LAMF is a secured loan, interest rates are generally lower than personal loans or credit card debt. Rates typically range from 9% to 13%, depending on the lender and collateral value, making it a cost-effective borrowing option.

3. Flexible Usage and Repayment

LAMF offers flexibility in the use of funds, whether for medical emergencies, education, or business needs. Moreover, borrowers can opt for flexible repayment terms and even prepay without hefty penalties.

Risks and Precautions

1. Market Volatility Impact

Since the NAV of mutual funds fluctuates, the collateral value may decrease during market downturns, potentially leading to margin calls from the lender.

2. Limited Loan Amount

Compared to selling your mutual funds outright, the loan amount is restricted to a percentage of the NAV, which may not meet large financial needs.

3. Interest Costs

While the interest rate is lower than unsecured loans, it still adds to your financial burden. Borrowers should ensure they have the means to repay the loan comfortably.

Recent Trends in LAMF

1. Digital Platforms Simplifying Processes
Fintech platforms are leveraging technology to simplify the process of availing loans against mutual funds. Apps like Abhiloans, ICICI Direct and Zerodha Coin offer seamless pledging and loan disbursement, with approvals in less than 24 hours.

2. Rising Awareness Among Millennials
Millennials are increasingly aware of LAMF, viewing it as a smart borrowing option. A survey by Groww in 2023 revealed that 40% of young investors prefer LAMF for short-term liquidity over traditional loans.

3. Increased Loan Limits
With the mutual fund industry witnessing a 16% CAGR growth in AUM over the past five years (AMFI data), lenders are raising the loan limits.

Is Loan Against Mutual Funds Right for You?

A loan against mutual funds is ideal if you need immediate funds but want to preserve your investments. It suits investors with a disciplined financial approach, capable of managing repayments without defaulting. However, if the market outlook is uncertain or you foresee difficulty in repaying the loan, selling your units might be a safer choice.

By making informed decisions, you can unlock the value of your mutual funds without compromising your financial goals.