Mutual funds are one of the most popular investment options, offering individuals a chance to grow their wealth over time through small, consistent contributions.
Whether you're saving for retirement, a child's education, or any other long-term financial goal, mutual funds offer a convenient and relatively low-risk option to build wealth.
However, there are times when you might need access to funds urgently. Instead of selling your mutual fund units—potentially disrupting your long-term investment strategy—you can opt for a loan against your mutual fund holdings.
This allows you to borrow funds without liquidating your investment, giving you quick access to liquidity while your mutual funds continue to grow.
In this guide, we will discuss in detail how to take a loan against mutual funds, the eligibility criteria, loan amount, interest rates, and required documents. This comprehensive overview will help you make an informed decision before applying for a loan.
What Is a Loan Against Mutual Funds?
A loan against mutual funds is a financial arrangement where you use your mutual fund units as collateral to secure a loan from a bank or a financial institution. The loan amount is typically a percentage of the Net Asset Value (NAV) of the mutual funds you hold.
Since the mutual funds are pledged as collateral, the lender faces less risk, allowing them to offer loans at lower interest rates compared to other unsecured loans.
This option allows you to get the financial assistance you need without having to sell your investments. By opting for a loan against mutual funds, you can preserve the potential growth of your investments while addressing your short-term liquidity needs.
Eligibility Criteria for a Loan Against Mutual Fund
Before applying for a loan against mutual funds, it is important to understand the eligibility criteria. Not everyone may be eligible to borrow against their mutual fund investments. Here are the key eligibility conditions that you need to meet:
1. Individual Investors
Any adult individual who holds mutual fund units is eligible to apply for a loan against them. The mutual funds must be in the individual's name, and they must meet the lender's specific requirements.
2. Non-Resident Indians (NRIs)
NRIs can also apply for a loan against their mutual funds. However, the terms and eligibility criteria for NRIs might vary depending on the lender's policies. Banks may require additional documentation, such as a copy of the passport or visa, proof of income, and other KYC (Know Your Customer) documents.
3. Hindu Undivided Families (HUFs)
HUFs, commonly found in India, can pledge their mutual fund investments to avail of a loan. The loan application process for HUFs is similar to that for individual investors, though specific documents related to the HUF structure may be required.
4. Trusts and Corporations
Corporate entities, including trusts and businesses that hold mutual funds, are also eligible to apply for loans against mutual funds. The mutual funds should be registered in the name of the entity, and the loan application process may involve more detailed paperwork, such as company registration documents and financial statements.
5. Minors
Minors are not eligible for loans against mutual funds. Since minors cannot legally enter into financial contracts, any mutual fund investments held by a minor cannot be used as collateral for loans.
Loan Amount for Mutual Fund Collateral
The amount you can borrow against your mutual fund holdings depends on several factors, including the Net Asset Value (NAV) of the mutual funds you hold and the type of funds you are pledging. Here’s a breakdown of the loan amounts available for different types of mutual funds:
Equity Mutual Funds:
If you have equity mutual funds, the loan amount you can borrow is typically up to 50% of the NAV. Since equity funds are subject to market volatility, the loan-to-value ratio tends to be lower to account for fluctuations in the market value of the units.
Fixed Income Mutual Funds:
For fixed income mutual funds, which tend to be more stable in terms of returns, the loan amount can be higher. Loans against fixed-income mutual funds can range from 70% to 80% of the NAV. Since these funds are less volatile than equity funds, they offer a higher loan-to-value ratio.
The loan amount depends not only on the type of mutual fund but also on the lender’s policies, your credit score, and other underwriting criteria.
Interest Rates on Loans Against Mutual Funds
One of the major reasons why many investors consider a loan against their mutual funds is the relatively low-interest rates compared to personal loans or credit card debt. Since mutual funds act as collateral, the lender’s risk is mitigated, which results in lower interest rates.
Typically, the interest rates for loans against mutual funds range from 10% to 12% per annum. This is significantly lower than the interest rates on personal loans, which can range from 15% to 20%, depending on your credit score and the lender’s terms.
Moreover, processing fees and foreclosure charges are often reduced or waived by most lenders when you opt for a loan against your mutual fund holdings. This makes it a cost-effective alternative to personal loans, especially if you need access to funds quickly.
Required Documents for a Loan Against Mutual Fund
When applying for a loan against mutual funds, you will need to submit several documents to verify your identity, your mutual fund holdings, and your financial stability. Below is a list of the common documents required:
- KYC Documents: Identity proof (Aadhaar card, PAN card, passport), address proof (utility bills, passport), and photographs.
- Proof of Mutual Fund Holdings: You need to submit a statement or a certificate from your mutual fund company that shows the units you hold in your account. This serves as proof of your mutual fund holdings and will be used as collateral for the loan.
- Income Proof: Banks and financial institutions will assess your ability to repay the loan, which requires providing proof of income. This can include salary slips, bank statements, income tax returns (for self-employed individuals), and business income statements (for business owners).
- Credit Score Report: Your credit score plays a critical role in determining your eligibility for a loan and the interest rate you’ll receive. Lenders typically require a credit score report from a credit bureau (like CIBIL in India). A higher credit score can help secure a loan at a lower interest rate.
- Loan Application Form: This includes all your personal details, the amount of the loan you’re requesting, the mutual fund units being pledged, and any other necessary information required by the lender.
- Bank Account Details: To disburse the loan, the lender will require your bank account details for the transfer of the loan amount.
Once you have these documents in place, you can approach your bank or financial institution to start the loan application process. The approval process typically takes a few days, depending on the lender’s internal procedures.
Advantages of Taking a Loan Against Mutual Fund
There are several advantages to taking a loan against mutual funds instead of selling your investment:
1. Retain Your Investment:
The most significant advantage is that you do not have to sell your mutual fund units. By borrowing against them, you allow your investment to continue growing, which is crucial for long-term financial goals like retirement planning or building wealth.
2. Lower Interest Rates:
Since mutual funds are used as collateral, the interest rates are significantly lower than those for unsecured loans, such as personal loans or credit card debt.
3. Quick Processing:
Loans against mutual funds are typically processed faster than traditional loans, as the lender already has collateral in place, reducing the need for lengthy verification processes.
4. Flexibility:
You can use the loan for any personal or business need, whether it’s for an emergency, medical expenses, business expansion, or other short-term financial goals.
5. Tax Benefits:
In certain cases, the interest paid on loans against mutual funds may be tax-deductible if the loan is used for business or investment purposes.
If you need urgent funds but don’t want to sell your mutual fund units, taking a loan against your mutual fund investments can be an excellent option. Just make sure you understand the terms, eligibility criteria, and interest rates before applying.