When in urgent need of funds, many investors often overlook a powerful financial tool—loan against mutual funds. This secured credit option allows investors to pledge their mutual fund units as collateral while still retaining ownership. While this facility offers many benefits like lower interest rates and quick disbursal, it also comes with potential pitfalls. In this guide, we’ll explore how loans against mutual funds work, and more importantly, highlight the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds.
What Is a Loan Against Mutual Funds?
A loan against mutual funds is a secured loan where investors pledge their mutual fund holdings in exchange for a sanctioned loan amount. This means that you don’t have to sell your investments to get immediate cash; your funds stay intact, and you get liquidity in hand. Leading banks and NBFCs like HDFC, ICICI, SBI, Tata Capital, and Bajaj Finserv offer this facility, often with competitive interest rates.
This is an excellent option for first-time borrowers or individuals with low credit scores. Unlike personal loans, which are unsecured and heavily depend on credit ratings, loans against mutual funds are based primarily on the Net Asset Value (NAV) of your holdings.
How It Works
To initiate a loan against mutual funds, the borrower pledges mutual fund units (either equity or debt) through an agreement with a lender. After the pledge, the lender assesses the current value of the units and sanctions a loan. The process is streamlined and quick, often taking just a day or two.
Loan-to-Value (LTV) ratios vary:
- Up to 50% for equity mutual funds
- 70–80% for debt mutual funds
Interest is charged only on the amount withdrawn and is calculated daily and debited monthly. Most lenders do not require a minimum credit score since the loan is secured.
7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds
Now that we understand the basics, let’s dive into the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds to help you make smarter financial decisions.
1. Ignoring Margin Shortfall Requirements
One of the most critical mistakes borrowers make is ignoring margin shortfall risks. If the market value of the pledged mutual funds falls, you are expected to pay the shortfall amount within a specific time (typically six days). Failure to do so can lead to the lender selling off your pledged units, which not only reduces your investment but can also affect your long-term wealth planning.
2. Not Understanding Loan-to-Value Ratio Limits
Another of the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds is misunderstanding how much you can actually borrow. Lenders will only offer a portion of your investment’s total value. Overestimating your eligibility can derail your financial plans and create funding gaps during emergencies.
3. Overlooking Fund Eligibility Criteria
Not all mutual funds are eligible for pledging. For example, New Fund Offers (NFOs) or funds with a very low Asset Under Management (AUM) may not be accepted by lenders. Overlooking this condition is one of the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds, and can lead to delays or even loan rejections.
4. Failing to Compare Interest Rates and Charges
Different lenders offer varied interest rates and fee structures. For instance, interest rates can range from:
- HDFC: 6.75% to 10.13%
- SBI: Around 10.10%
- ICICI: 10.75% to 11.75%
- Axis: Up to 13.75%
- NBFCs like Tata Capital and Bajaj Finserv may have different pricing
Not comparing these rates and hidden charges like processing fees or account maintenance costs is one of the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds that can cost you heavily.
5. Assuming You Can Continue Redeeming Funds
A common misconception is that you can redeem your pledged mutual fund units while servicing the loan. That’s incorrect. Until the loan is entirely repaid, you cannot redeem or switch your mutual fund holdings. This can affect your liquidity and investment strategy.
This false assumption is a crucial entry in the list of 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds that can hinder financial flexibility.
6. Ignoring the Tax Implications and Exit Loads
Although a loan against mutual funds doesn’t have direct tax implications like redemption does, if the lender sells off your units due to non-payment, capital gains tax and exit loads might apply. Not accounting for this scenario is another of the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds.
7. Borrowing Without a Clear Repayment Strategy
Lastly, taking a loan without a concrete plan to repay it is one of the most damaging entries in the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds. While interest may seem low and flexible, unpaid dues can accumulate, and the lender has the legal right to sell your pledged units if repayments are missed.
Benefits of Loan Against Mutual Funds
Despite the potential risks, this loan option offers numerous advantages:
- Quick processing time compared to personal loans
- Lower interest rates, especially from NBFCs
- No need to liquidate your mutual fund portfolio
- No credit score barrier, making it ideal for new borrowers
Personal Loans vs Loan Against Mutual Funds
| Criteria | Personal Loan | Loan Against Mutual Funds |
|---|---|---|
| Secured/Unsecured | Unsecured | Secured |
| Interest Rate | 10.30% – 24% | 6.75% – 13.75% |
| Credit Score Required | Yes | Not necessarily |
| Processing Time | Slower | Faster |
| Collateral Required | No | Yes |
| Risk of Liquidation | No | Yes (if shortfall unpaid) |
This comparison further justifies why understanding the 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds is vital for borrowers evaluating both options.
Banks and NBFCs Offering Loans Against Mutual Funds
Here are popular banks and their average interest rates:
| Bank | Loan Against MF Rate | Personal Loan Rate |
|---|---|---|
| SBI | 10.10% | 10.30%–15.30% |
| HDFC | 6.75%–10.13% | 10.90%–24% |
| ICICI | 10.75%–11.75% | 10.75%–19% |
| Axis Bank | 11.49%–13.75% | 11.25%–22% |
| Bank of Baroda | 9.90%–11.25% | 10.90%–18.50% |
NBFCs like Bajaj Finserv, Tata Capital, and Volt Money also offer competitive rates and relaxed documentation.
Final Thoughts
A loan against mutual funds can be a lifesaver during emergencies or when quick liquidity is needed. However, like any financial instrument, it must be handled wisely. The 7 Common Mistakes to Avoid When Taking Loan Against Mutual Funds discussed above are essential guardrails to prevent losses and protect your financial future.
Avoiding these mistakes helps ensure that you not only secure quick access to capital but also preserve the long-term value of your mutual fund investments. Be sure to evaluate lenders, assess risks, and develop a clear repayment strategy before signing any agreement.