When You we think about mutual funds, most of us view them as “don’t touch until the goal is reached” money. But what if you need some liquidity before that? That’s where a loan against mutual funds comes in.
Unlike redeeming your funds, where you sell them outright, this loan allows you to pledge your mutual fund units as collateral. In return, you get access to credit without selling your investments, keeping them intact. It’s like borrowing against your future goal.
Once you pledge your mutual funds, the lender (usually a bank or NBFC) gives you a loan based on a percentage of the market value of your holdings. The percentage depends on the type of funds you hold. For instance, equity funds typically come with a lower loan-to-value ratio because their prices can swing wildly. On the other hand, debt and liquid funds often have higher ratios as they are less volatile.
The process is simple and most often completed online. You log into the lender’s platform, consent to view your holdings, and choose the funds you wish to pledge. For demat accounts, the pledge is handled through NSDL or CDSL. Once you authenticate the request via OTP or net banking, your units are pledged, and the lender sanctions the loan limit.
Once the loan is approved, it can be structured either as a term loan with fixed EMIs over a set period or as an overdraft, where interest is only charged on the amount actually borrowed. The pledged units remain in your name, and you continue to participate in market fluctuations, receiving dividends (if any). However, you can’t sell the pledged units without clearing the loan first.
While this loan option seems convenient, there are some risks and costs to consider.
First, the value of your pledged units is determined by their current market price, not the original investment amount. If the equity market dips, the value of your pledged units may fall, and your loan-to-value ratio could worsen. This may trigger a margin call, asking you to either pay back part of the loan or pledge more units. If you fail to respond, the lender can sell part of your holdings to recover the shortfall.
Second, while the interest rate on these loans is usually lower than that of unsecured personal loans, it’s still not exactly “cheap money”. If the loan stretches over a longer period, the interest paid could be substantial. In some cases, it could exceed what you’d pay for a regular personal loan.
Third, while there are fees for the loan, such as processing charges, pledge and de-pledge fees, and penal interest for delays, they can add up if you're not careful.
Loans against mutual funds are not meant to fund impulsive purchases or expenses like a foreign holiday, buying a new phone, or topping up speculative trading. If you’re borrowing against your long-term investment portfolio to fund such expenses, you are layering risk on top of risk.
It’s also not a good idea if your income is unstable or if you’re already managing multiple EMIs or credit card dues. In this situation, adding another loan that can affect your investment security if markets fall is risky. It’s better to sell part of your mutual funds consciously and realign your financial plan rather than resorting to borrowing.
If you choose to take a loan against your mutual funds, treat it as a tool you pull out only when necessary. Follow these simple guidelines to avoid turning it into a financial burden:
Limit the loan amount: Only borrow an amount you can comfortably repay within 6-18 months from your regular cash flow or a clear inflow (e.g., a bonus or maturity of another instrument).
Don’t pledge funds too close to goal dates: If your goal is within a year or two, it’s better not to pledge those funds. Borrowing against funds that are near their goal date could jeopardise your plans.
Use overdraft facilities: Prefer overdraft loans where interest is charged only on the amount you actually borrow. Prepay as soon as you have surplus cash to reduce the loan amount.
Monitor market conditions: Keep track of the market value of your pledged units so that you’re not caught off guard by a margin call.
A loan against mutual funds sits somewhere between selling your investments and taking out an unsecured loan. If used wisely and for the right reasons, it can help you navigate a short-term liquidity crunch without derailing your long-term plans. However, used without a clear repayment strategy, it can turn your investment portfolio into a source of stress, not security.