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Explained: What is loan against mutual funds, and how do they work?

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Mutual funds are often seen as long-term investment tools, but did you know they can also serve as collateral for short-term liquidity? For the mutual fund investors, when emergencies or short-term financial needs arise, selling investments might seem like the easiest solution but liquidating mutual funds prematurely can disrupt the long-term financial goals.

An alternative worth considering is a loan against mutual funds (LAMF) that allow investors to access funds while retaining ownership of their investments.

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Loan against mutual funds

A loan against mutual funds enables investors to pledge their mutual fund units as collateral to borrow money. It allows investors to borrow money by pledging their mutual fund holdings, without the need to sell them. It’s a smart way to meet immediate financial needs while keeping long-term investments intact.

Lenders assess the value of their pledged units and typically offer a loan amount based on a percentage of their current market value. This option is particularly attractive because it helps the investors to meet financial needs without selling their investments, preserving their potential for growth.


In other words, it is a financial solution that allows investors to borrow money against their mutual fund units without selling them. It works as an overdraft facility, and the interest is charged only on the amount availed as credit.

Loans against mutual funds are processed quickly, often within one or two days, since the collateral significantly reduces the lender's risk. The amount one can borrow depends on the type of mutual funds they hold. For equity mutual funds, the loan-to-value (LTV) ratio is generally 50-70%, while for debt mutual funds, it can go up to 80-90%.

During the loan period, one can continue to own their mutual funds, which means they can still earn dividends or interest on the pledged units, adding to the appeal of this financial instrument.

Benefits of loans against mutual funds

This type of loan offers several advantages. It allows investors to access funds without selling their mutual funds, enabling them to continue benefiting from market appreciation. Since the loan is secured, the interest rates are lower compared to personal loans or credit cards.

Another benefit is repayment flexibility, with tenures ranging from a few months to a few years. Additionally, the investor retains the ownership of their mutual funds, meaning they can continue earning dividends or interest during the loan tenure.

While loans against mutual funds are convenient, they come with certain risks. Market volatility can reduce the value of the pledged mutual funds, which may lead to a margin call. This requires the investors to either top up the collateral or repay part of the loan to maintain the loan-to-value (LTV) ratio.

Additionally, the mutual fund units cannot be redeemed or switched as long as the lien exists. If they default on the loan, the lender has the right to sell their pledged units, potentially causing a financial setback.

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How to take a loan against mutual funds

To get a loan against mutual funds, the first step is to choose a lender. Banks, non-banking financial companies (NBFCs), and fintech platforms typically offer this service. Once the investor selects a lender, they should check whether the lender accepts the specific mutual funds investor holds as collateral.

The application process involves providing details of the mutual fund investments, including folio numbers and scheme names. The investor will also be required to sign a lien agreement, authorising the lender to mark a lien on the pledged units.

A lien gives the lender the right to sell the pledged units if the borrower fails to repay the loan. Once the lien is marked, the loan amount is disbursed to the borrower's account.

How do they work?


Any retail investor with mutual fund investments and proper KYC compliance can apply for this loan. It is particularly useful for individuals who require emergency funds but don’t wish to disturb their long-term financial goals.

To begin, you initiate the process with your bank or lending institution and pledge mutual fund units. These units can be in demat or physical form, though most lenders prefer demat. The value of the loan is determined based on the net asset value (NAV) of the funds. Typically, lenders offer up to 60–70% of the NAV for equity funds and 80–85% for debt funds.

Once the pledge is confirmed with the mutual fund registrar (such as CAMS or KFintech), the funds are disbursed—either as a lump sum loan or a line of credit. In many cases, the lender offers an overdraft facility, allowing you to withdraw only the amount you need and pay interest only on that amount used. Repayment can be done through EMIs or flexible repayments, depending on the agreement. Once the full loan amount is repaid, the mutual fund units are unpledged.

Interest rates on these loans generally range from 8% to 12% per annum. The tenure can be up to one year or more, and some lenders offer rolling overdraft facilities that can be renewed periodically.

This facility offers multiple benefits. It provides quick access to funds without selling your investments. Your money continues to remain invested, earning potential returns. Since it is a secured loan, the interest rates are lower compared to personal loans. Also, if you choose the overdraft option, you pay interest only on the amount you utilise, not the sanctioned limit.

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Suitability


A loan against mutual funds is ideal for individuals seeking quick funds without disrupting their long-term financial goals. It is also a suitable option for investors who need liquidity but want to avoid selling their mutual funds during unfavourable market conditions. Furthermore, this loan is a cost-effective alternative to unsecured credit options like personal loans or credit cards.

Loans against mutual funds are a practical solution for accessing funds while keeping your investments intact. However, they should be used judiciously, with careful consideration of repayment capacity and potential risks. Before availing of such a loan, one should compare lenders and thoroughly understand the terms and conditions. By doing so, the investor can make the most of this financial tool while staying on track with their investment goals.
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