A “Loan Against Mutual Funds” (LAMF) is a financial facility that allows you to borrow money by using your existing mutual fund units as collateral. Instead of selling your investments to meet an urgent financial need, you can pledge them with a bank or Non-Banking Financial Company (NBFC) and get a loan. This way, your mutual funds continue to remain invested and potentially grow, while you get access to immediate liquidity.

It’s a popular option for individuals who need quick funds but don’t want to disrupt their long-term investment goals or incur capital gains tax by selling their mutual fund units.

How Loan Against Mutual Funds Works

1. Pledging/Lien Marking: You pledge your mutual fund units as security with the lender (bank or NBFC). The lender then places a “lien” on these units, which means you cannot redeem or sell them until the loan is fully repaid. However, you retain ownership of the units and continue to receive any dividends or benefits they might accrue.

2. Loan Amount (Loan-to-Value – LTV): The loan amount sanctioned depends on the Net Asset Value (NAV) of your pledged mutual fund units and the lender’s Loan-to-Value (LTV) ratio.

   • Equity Mutual Funds: Typically, the LTV ratio for equity mutual funds is around 45% to 50% of their NAV, due to their higher volatility.

   • Debt Mutual Funds: For debt mutual funds, which are considered more stable, the LTV ratio can be higher, often ranging from 70% to 80% of their NAV.

   • Lenders have an “approved list” of mutual funds against which they offer loans.

3. Overdraft Facility: Most LAMFs are offered as an overdraft facility. This means a credit limit is set, and you can withdraw funds as and when you need them, up to that limit.

4. Interest Calculation: Interest is charged only on the amount you actually utilize and for the number of days you use it, not on the entire sanctioned loan limit. This offers flexibility in repayment.

5. Repayment: You typically pay interest on a monthly basis. The principal can often be repaid flexibly at your convenience, either in parts or as a lump sum, anytime during the loan tenure. Many lenders do not charge prepayment penalties.

6. Release of Lien: Once the loan is fully repaid, the lender removes the lien on your mutual fund units, and they become fully accessible to you again.

Benefits of Loan Against Mutual Funds

1. No Liquidation of Investments: This is the primary advantage. You don’t have to sell your mutual fund units, especially if the market is down or if selling would disrupt your long-term financial plan or attract significant capital gains tax. Your investments continue to grow while you meet your short-term cash needs.

2. Lower Interest Rates: Since it’s a secured loan (backed by collateral), LAMFs typically have lower interest rates compared to unsecured loans like personal loans or credit card loans. Interest rates can range from 9% to 14% p.a., often significantly lower than personal loan rates (which can be 12-20% or more).

3. Quick and Easy Access to Funds: The process is often fully digital and quick, with loan approvals and disbursals happening within minutes or a few hours, as the collateral mitigates much of the lender’s risk.

4. Flexible Repayment: As an overdraft facility, you pay interest only on the amount utilized, and you have flexibility in principal repayment. There are usually no foreclosure or prepayment charges for individuals.

5. Retention of Ownership Benefits: You continue to own the mutual fund units and receive any dividends, bonuses, or capital appreciation that they might generate while they are pledged.

6. No Impact on Credit Score (Generally): Unlike unsecured loans where your credit score is a major factor, LAMFs are secured. While a CIBIL score is checked, eligibility is primarily based on the value of your pledged assets. Timely repayment can even help build a good credit history.

7. Diverse Usage: The funds obtained can be used for various purposes – business needs, medical emergencies, education expenses, wedding costs, or any other personal financial requirement (except speculative trading in the stock market or anti-social activities).

Risks and Considerations

1. Margin Calls: This is the most significant risk. If the NAV of your pledged equity mutual funds falls significantly due to market volatility, the LTV ratio might be breached. The lender may then issue a “margin call,” requiring you to either:

   • Pledge additional mutual fund units as collateral.

   • Repay a portion of the outstanding loan amount to bring the LTV back within acceptable limits.

   • Failure to meet a margin call can lead to the lender selling a portion of your pledged units to recover their dues, potentially at an unfavorable market price.

2. Loan-to-Value (LTV) Limitations: You can only borrow a percentage of your mutual fund value, not the full amount. This might not be sufficient for very large financial needs.

3. Restriction on Pledged Units: While pledged, you cannot redeem, sell, or switch the units. This can restrict your ability to rebalance your portfolio or take advantage of market opportunities with those specific units.

4. Not All Funds Eligible: Lenders have an approved list of mutual fund schemes against which they offer loans. Schemes with lock-in periods (like ELSS) or closed-ended funds are typically not eligible.

5. Interest Costs: While lower than unsecured loans, you still pay interest. Ensure the cost of the loan justifies your need for immediate liquidity.

6. Default Consequences: If you default on the loan, the lender has the legal right to sell your pledged mutual fund units to recover the outstanding loan amount. If the sale proceeds are insufficient, you will still be liable for the remaining debt.

7. Processing Fees and Other Charges: While interest rates are low, be aware of processing fees, stamp duty, and potential penal charges for delayed payments.

Who Should Consider a Loan Against Mutual Funds?

LAMF is a suitable option for:

• Investors with a long-term investment horizon: Who want to avoid liquidating their well-performing mutual funds for short-term needs.

• Individuals facing temporary liquidity crunch: Who need quick funds for emergencies or planned expenses without disturbing their core investments.

• Those looking for a lower-cost borrowing option: Compared to personal loans or credit card debt.

• Investors who understand market risks: And are prepared to meet potential margin calls if the value of their pledged funds falls.

• Individuals with a good portfolio of approved mutual funds: Especially diversified ones to mitigate margin call risk.

Before opting for a Loan Against Mutual Funds, it is essential to compare offers from different lenders, understand all terms and conditions, assess your repayment capacity, and consider the potential impact of market fluctuations on your pledged assets.