Sometimes, borrowing against MFs is more sensible than redeeming them

Instead of borrowing to the hilt, maintain a buffer to avoid margin calls during spells of market volatility

With younger customers increasingly preferring mutual funds to bank deposits, several private banks are entering the loan against mutual funds (LAMF) business. According to a recent media report, south-based private lenders such as Karur Vysya Bank and CSB Bank plan to enter this segment soon. South Indian Bank began offering the facility in March, while Canara Bank, which introduced it last year, plans to scale up its business. 

For investors, the product can provide quick liquidity without forcing them to redeem their mutual fund units. But borrowers should understand the costs, margin risks, and repayment obligations before using it. 

How the product works 

The minimum loan amount is usually ₹25,000 for digital LAMF products. “Banks may offer up to ₹1 crore against equity funds and ₹5 crore against debt funds. Non-banking financial companies (NBFCs) may offer up to ₹2 crore against equity funds and ₹5 crore against debt funds,” says C.R. Chandrasekar, founder and chief executive officer (CEO), DhanLAP. 

Interest rates depend on the borrower’s profile, the lender’s policy, and the underlying portfolio. “They generally start at around 9–10 per cent annually and can go beyond 15 per cent,” says Adhil Shetty, CEO, Bankbazaar. 

“The tenure may range from three months to three years and can be renewed,” says Chandrasekar. Processing charges are usually modest, ranging from 0.5 per cent to 2 per cent of the sanctioned amount. Some digital LAMF products may not charge a processing fee. 

The loan-to-value (LTV) ratio is regulated. “Lenders typically offer up to 50 per cent of the value for equity mutual funds and up to 80 per cent for debt mutual funds,” says Krishna Kanhaiya, CEO, Mirae Asset Financial Services (India). 

Borrowers may repay through equated monthly instalments (EMIs). They may also use an overdraft facility, which works as a revolving credit structure. In this case, the lender charges interest only on the amount used. 

“Since the loan is secured against existing investments, lenders generally approve and disburse it faster than unsecured loans,” says Shetty. 

Pledge less volatile funds 

Lenders usually prefer to lend against funds with lower volatility. “Taking a loan against a relatively stable fund reduces the likelihood of margin calls or additional collateral requirements during volatile markets,” says Shetty.  

“Debt funds are better suited for this facility because they are less volatile and lenders offer higher LTV ratios against them. Hybrid funds come next, followed by equity funds,” says Chandrasekar. Among diversified equity schemes, large-cap equity mutual funds are more suitable because they tend to be relatively stable and liquid. 

Borrowers should avoid pledging smallcap funds, sectoral, thematic, and commodity funds because they are volatile and qualify for lower LTV ratios. “The sharp movements in their net asset values can trigger margin requirements,” says Harsh Vira, chief financial planner and founder, FinPro Wealth. 

Lenders also avoid closed-end funds and others that have limited liquidity. 

Use it for temporary liquidity 

LAMF is a low-cost secured loan that allows investors to leverage their own assets. “The product can work well for investors seeking temporary liquidity while continuing to remain invested in the market,” says Shetty. 

These loans are generally suitable for short- to medium-term liquidity needs rather than long-term borrowing. 

Borrowers often use them to repay high-interest credit card debt, pay education fees, fund a home down payment, meet vacation shortfalls, pay for medical emergencies, or manage other temporary mismatches in cash flows. Some use them to pay tax, meet working capital gaps, fund business expenses, or bridge short-term funding needs. 

“Some investors use LAMF as leverage to invest in high-yield products, though this is risky,” says Vira.  

Know the advantages 

LAMF allows investors to access liquidity while staying invested. “It prevents short- to mid-term financial needs from interrupting or delaying long-term wealth creation,” says Chandrasekar. 

Investors can also avoid the tax implications linked to redemption. Another advantage is that the investor benefits from any appreciation in the value of the pledged units during the loan tenure. 

The interest rate is usually lower than that on an unsecured personal loan. Other advantages include no prepayment charges, overdraft availability (interest charged only on the amount borrowed), multi-year renewal, and the flexibility to replace pledged funds during the tenure. 

Many lenders now offer largely digital processes, which makes approval and disbursal quicker. Documentation requirements are also limited. 

Market volatility can spell trouble  

Market fluctuations can reduce the value of pledged mutual fund units below the required LTV level. Equity-oriented mutual funds are especially vulnerable during volatile market phases. 

“If the value of pledged assets falls, the borrower may have to pay the difference or mark a lien on more mutual fund units,” says Chandrasekar. 

Borrowers may get only seven days to regularise the account if there is an LTV breach of more than 50 per cent. “Higher LTV breaches can have even shorter regularisation timelines,” says Kanhaiya. 

If the borrower cannot compensate for the fall in asset value or make monthly payments, the lender may sell the mutual fund units. “Forced liquidation during market downturns locks in losses and disrupts the investor’s long-term investment strategy,” says Feroze Azeez, joint CEO, Anand Rathi Wealth. 

Borrow or redeem? 

Borrowing against mutual funds makes sense when the need is short term. “Redeeming mutual funds may not be efficient in such cases because it breaks compounding, may attract capital gains tax, involve exit loads and may cause the investor to miss a market recovery,” says Kanhaiya. 

Azeez explains that leverage is relatively more attractive when market valuations are reasonable and froth is limited. 

 

Redemption may be more suitable if the financial need is long term or the original goal for which the investment was made has been achieved. If the investment was meant for a short-term goal or for parking money, redemption may be the better option.

“Redemption may also be better if repayment visibility is uncertain, the investor is financially stretched, or the investment no longer aligns with financial goals,” says Kanhaiya. 

Before borrowing, investors should ensure that expected returns meaningfully exceed borrowing costs and that the investment has a high probability of delivering the intended outcome. 

Redemption may also be better if the investor is uncomfortable with interest-servicing obligations or margin calls. 

Maintain a buffer 

Borrowers should avoid using the full eligible loan amount. They should maintain a reasonable buffer, especially when borrowing against equity-oriented funds. This can help them manage short-term market volatility.  

Investors should first assess their existing borrowing and EMI obligations. “If total EMI commitments after taking LAMF exceed roughly 50 per cent of monthly income, the leverage may no longer be financially prudent,” says Azeez. 

Vira cautions that borrowers should avoid using these loans for speculative investments or unnecessary spending because leverage can amplify financial pressure.  

According to Azeez, those using the loan for luxury purchases should restrict the limit to around 20–25 per cent instead of fully utilising their borrowing capacity. 

Borrowers should also avoid delaying or ignoring even small overdue amounts. “All overdues are reported to credit bureaus, and reporting frequency is becoming faster, including weekly reporting in many cases,” says Kanhaiya. 

Customers should regularly track loan utilisation, interest servicing and repayment obligations.

Dos and don’ts  

• Avoid borrowing without clear repayment visibility 
• Use leverage in moderation instead of  maximising borrowing capacity
• Maintain repayment discipline to protect credit profile
• Do not treat LAMF as easily accessible liquidity for unnecessary spending or aggressive risk-taking 

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The writer is a Mumbai-based independent journalist