Is Loan Against Mutual Funds a Better Option Than Selling?

When faced with urgent financial requirements, many investors consider redeeming their mutual fund investments to generate liquidity. However, selling investments prematurely may lead to loss of potential gains, tax liabilities, and disruption in long-term wealth creation. Instead of breaking investments, a loan against mutual funds offers an efficient alternative by allowing investors to borrow money while keeping their investments intact.

With a competitive loan against mutual funds interest rate, investors can secure funds at a lower cost compared to unsecured loans, such as personal loans or credit cards. This financial tool helps maintain the benefits of compounding, ensures continued market participation, and provides flexible repayment options.

This article explores how loans against mutual funds (LAMF) work, their advantages, and why they are often a smarter choice than redeeming mutual fund units prematurely.

What is a loan against mutual funds?

A loan against mutual funds is a secured borrowing facility where investors pledge their mutual fund units as collateral to access funds from a lender. The amount sanctioned depends on the net asset value (NAV) of the pledged mutual funds. Typically, equity mutual funds offer a loan of up to 50% of their NAV, whereas debt mutual funds allow borrowing up to 80% of their NAV.

Since mutual fund units serve as collateral, lenders offer lower interest rates compared to unsecured loans. Borrowers can continue earning dividends and potential capital appreciation while utilising the required funds for personal or business needs.

Key features of a loan against mutual funds

1. Collateral-backed borrowing – The loan amount is determined by the NAV of pledged mutual fund units.
2. Lower interest rates – The loan against mutual funds interest rate is more affordable than unsecured loans.
3. Retention of investment benefits – Investors continue to earn dividends and capital gains on pledged funds.
4. Flexible repayment options – Borrowers can opt for structured EMIs or interest-only payments.
5. Quick processing – Digital lending platforms ensure fast disbursal with minimal documentation.
6. Overdraft facility – The loan is structured as an overdraft, where interest is charged only on the utilised amount.

Why opt for a loan against mutual funds instead of redeeming investments?

1. Avoids premature redemption losses

Mutual funds are designed for long-term wealth accumulation. Redeeming investments early can lead to losses, especially if the market is in a recovery phase. With a loan against mutual funds, investors can access liquidity without selling assets at an unfavorable price, ensuring they benefit from future market upswings.

2. Lower cost compared to unsecured loans

The loan against mutual funds interest rate is significantly lower than personal loans and credit card debt, which can have interest rates as high as 12-18%. In contrast, loans against mutual funds typically have an interest rate between 7-10%, making them a cost-effective option for borrowing.

3. Tax efficiency

Selling mutual funds can lead to capital gains tax, which varies based on the holding period. Equity mutual funds held for less than a year attract a 15% short-term capital gains tax, while debt mutual funds are taxed as per the investor’s income tax slab. A loan against mutual funds helps defer taxes while providing immediate liquidity.

4. Continued portfolio growth

Investments in mutual funds generate wealth through compounding. Selling units disrupts this process, whereas pledging mutual funds for a loan allows investors to retain ownership and continue benefiting from market appreciation.

5. Minimal documentation and quick disbursal

Unlike traditional loans, a loan against mutual funds requires minimal paperwork. Most lenders offer a fully digital process, ensuring that funds are disbursed within a short period. This feature makes it ideal for individuals who need urgent financial assistance without a lengthy application process.

6. No impact on credit score

Since loans against mutual funds are secured loans, they do not impact the borrower’s credit score significantly. In contrast, failing to repay an unsecured loan can severely affect an individual’s credit history.

Types of mutual funds eligible for loans

Lenders typically offer loans against mutual funds for the following categories:

• Equity mutual funds – Loans up to 50% of NAV.
• Debt mutual funds – Loans up to 80% of NAV.
• Hybrid funds – Loan eligibility depends on the asset allocation within the fund.

Loan against mutual funds vs redeeming investments

When should you consider a loan against mutual funds?

• Short-term liquidity requirements – When funds are needed without disturbing investments.
• Market downturns – To avoid selling mutual funds at a loss.
• Business expansion – To leverage investments while keeping financial growth intact.
• Lower borrowing costs – When compared to high-interest personal loans.
• Emergency expenses – For medical, educational, or other unforeseen expenses.

Risks associated with a loan against mutual funds

While loans against mutual funds provide numerous benefits, investors should be aware of the following risks:

1. Market volatility – A sharp decline in NAV may reduce the pledged fund value, leading to a margin call from the lender.
2. Interest costs – Though lower than unsecured loans, interest expenses must be considered when evaluating financial needs.
3. Margin calls – If the value of the pledged mutual funds declines significantly, borrowers may need to provide additional collateral or repay part of the loan.
4. Limited eligibility – Not all mutual funds qualify for pledging, as lenders have specific criteria for approved funds.

How to apply for a loan against mutual funds

Applying for a loan against mutual funds is a simple process:

1. Check eligibility – Verify that the mutual funds meet the lender’s criteria.
2. Choose a lender – Compare interest rates and terms offered by different financial institutions.
3. Apply online – Submit the application through the lender’s digital platform.
4. Pledge mutual fund units – Authorise the lender to mark a lien on the pledged units.
5. Loan disbursement – Once approved, the funds are credited to the borrower’s account.

Conclusion

A loan against mutual funds is a powerful financial tool that allows investors to meet liquidity needs while preserving their investment portfolio. With a competitive loan against mutual funds interest rate, lower borrowing costs, and continued asset appreciation, this option is far more beneficial than breaking investments prematurely.

By leveraging a loan against mutual funds, individuals can efficiently address short-term financial requirements while maintaining their long-term investment strategy. Understanding the risks and benefits associated with this facility helps investors make informed financial decisions aligned with their goals.