Loan against mutual funds: A flexible way to raise cash without selling investments

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Most of us think of mutual funds as “don’t touch till goal” money. A loan against mutual funds sits somewhere in between: you don’t redeem your funds, but you let a bank or NBFC use them as security to give you a line of credit.

The units stay in your name, but are marked as pledged. You still participate in market ups and downs, you continue to get dividends (if any), and you retain your long-term investment history. What you lose temporarily is the freedom to sell those units without clearing the loan first.

Typically, lenders offer a percentage of the current value of your units as a loan. For equity funds, this is usually lower because prices can swing sharply; for debt and liquid funds, the loan-to-value is higher as they move more slowly.

How the loan is set up in practice

In most cases the entire process is online. You log in to the lender’s platform, select “loan against securities” or “loan against mutual funds”, give consent to view your demat or mutual fund holdings, and choose which schemes to pledge.

For demat units, the pledge is created through NSDL or CDSL. If your funds are held in statement of account (SOA) form, many lenders now integrate with registrars so that even those units can be pledged. Once you authenticate the pledge request (through OTP or net banking), the lender marks those units as pledged and sanctions a limit.

The money then comes either as a term loan (fixed EMI over a defined tenure) or as an overdraft/loan-against-limit, where you pay interest only on the amount actually used. When you repay in full, the lender removes the pledge and the units become free again.

Costs and risks you should not ignore

It is easy to focus on the convenience and forget the trade-offs. A few points are worth keeping in mind.

First, the lender looks at the market value of your funds, not what you originally invested. If equity markets fall sharply, the value of the pledged units drops, and your loan-to-value ratio worsens. At some point, the lender may send you a margin call asking you to either part-prepay the loan or pledge more units. If you don’t act, the lender has the right to sell part of your holdings to recover the shortfall.

Second, the interest rate is usually lower than an unsecured personal loan, but it is not “cheap money”. If you stretch the loan for years instead of months, the interest cost can be substantial, and you may end up paying more than you would have with a straightforward personal loan taken and closed quickly.

Third, there can be processing fees, pledge and de-pledge charges, statement charges and penal interest on delays. They look small in the brochure, but they add up if you treat the facility casually.

When a loan against mutual funds is a bad idea

This product is not meant to fund impulse decisions. If the reason is a foreign holiday, a new phone, or topping up speculative trading, you are taking risk on top of risk. You are also borrowing against the very portfolio that is supposed to fund your future goals.

It is also a poor choice if your income is volatile and you are already juggling EMIs or credit card dues. In that situation, adding another lender who can sell your investments if markets fall is not wise. Selling some funds consciously and resetting your financial plan is safer than drifting into a loan you cannot comfortably manage.

How to use this facility sensibly

If you do decide to use a loan against mutual funds, treat it like a tool you pull out rarely and put back quickly. Keep a few simple rules for yourself.

Limit the amount to what you can clear in 6–18 months from regular cash flow or a clearly expected inflow such as a bonus or maturity of another instrument. Avoid pledging funds that are very close to their goal date; if the goal is one or two years away, you probably shouldn’t be borrowing against it.

Prefer overdraft-style facilities where interest is charged only on the amount you actually draw down, and prepay whenever you have surplus cash. Keep an eye on markets and the value of your pledged units, so that a margin call does not come as a surprise.

The bottom line

A loan against mutual funds sits in a grey zone between selling your investments and taking an expensive unsecured loan. Used for the right reasons, for a short period, it can help you ride out a cash crunch without derailing long-term plans. Used casually, without a clear repayment path, it can turn your portfolio into a source of stress instead of security.