For investors seeking liquidity without disturbing long-term investments, the loan against mutual funds facility has become a reliable financial tool.
It allows individuals to pledge mutual fund units and access credit quickly, all while maintaining their portfolio’s market exposure. One of the most crucial factors in this facility is the loan against mutual funds interest rate, which varies significantly depending on the type of mutual fund being pledged.
In this article, we explore how different mutual fund categories affect interest rates, why lenders assess them differently, and what investors should consider to optimise borrowing costs.
What is a loan against mutual funds?
A loan against mutual funds is a secured loan where investors offer their mutual fund holdings as collateral. The lender marks a lien on the pledged units, which restricts redemption until the loan is repaid in full. However, the investor retains ownership of the units and continues to benefit from returns and dividends, if applicable.
The loan can be structured as a term loan or overdraft facility, depending on the investor’s needs. Most lenders now provide an online process, making applications faster and less document-intensive.
How the type of fund impacts interest rates
Lenders assess risk based on the underlying volatility, liquidity, and stability of the mutual fund being pledged. As a result, the category of mutual fund directly affects the interest rate offered.
Debt mutual funds
Debt funds are considered less risky because they invest in fixed-income securities. These funds show low volatility and offer predictable returns.
Debt mutual funds usually attract lower interest rates ranging between 8 percent and 11 percent per annum.
Since they carry minimal market risk, lenders are more comfortable extending higher loan amounts against these funds.
They are ideal for conservative investors looking for low-cost borrowing without excessive exposure to capital market swings.
Equity mutual funds
Equity mutual funds invest in shares of listed companies and are subject to market fluctuations. They carry a higher degree of risk, especially during market volatility.
Equity mutual funds usually attract higher interest rates, generally ranging from 10 percent to 13 percent per annum.
Due to their price volatility, the loan sanctioned is typically lower compared to debt funds, even when the fund value is similar.
Lenders may also reduce the loan-to-value ratio as a precautionary measure against market downturns.
Hybrid mutual funds
Hybrid funds invest in a mix of debt and equity instruments. Their risk profile depends on the proportion of each asset class in the portfolio.
Hybrid funds with a higher allocation to debt instruments may attract slightly lower interest rates than those with equity-heavy compositions.
Interest rates for hybrid mutual funds generally range between 9 percent and 12 percent per annum.
Lenders evaluate these funds on a case-by-case basis, depending on their composition and recent performance.
Factors beyond fund type that influence interest rates
While the mutual fund category plays a major role, lenders also consider other parameters before determining the final loan against mutual funds interest rate.
Funds with historically stable performance and high liquidity usually attract lower rates than volatile or illiquid schemes.
Mutual funds managed by reputable asset management companies may be viewed more favourably by lenders.
A high credit score and strong repayment history can lead to discounted interest offers, even on equity fund pledges.
Borrowers with a long-standing relationship with the lender may be eligible for preferential interest rates.
Loan-to-value ratio and its connection to fund type
The loan-to-value (LTV) ratio is the percentage of the mutual fund’s current value that the lender is willing to offer as a loan. This ratio is directly influenced by the type of fund pledged.
Debt mutual funds may allow a loan-to-value of up to 70 percent of the total fund value.
Equity mutual funds typically offer between 50 and 60 percent of the fund’s current market value.
Hybrid funds fall somewhere in between, depending on how much debt they hold.
For example, if an investor holds Rs. 10 lakh in equity mutual funds, they may receive a loan of Rs. 5 to 6 lakh, whereas the same amount in debt funds could allow borrowing of up to Rs. 7 lakh.
Charges and total cost of borrowing
In addition to the interest rate, borrowers must also account for associated charges that affect the total cost of borrowing.
Lenders typically charge a processing fee between 0.5 percent and 2 percent of the loan amount.
Documentation or administrative charges, though nominal, may range from Rs. 500 to Rs. 1,500.
Registrar services may apply a lien marking fee for processing the pledge.Renewal charges may apply for overdraft facilities that extend beyond one year.
Delays in EMI payments or overdraft repayments can result in penal interest being added to the outstanding balance.
Comparing not just the interest rate but also these charges across lenders can help borrowers find the most cost-effective loan structure.
Choosing the best fund to pledge
For investors with multiple types of mutual funds, strategic selection can optimise the borrowing experience.
Pledging debt mutual funds is often the most cost-efficient due to their lower risk and higher loan eligibility.
Investors should avoid pledging high-risk or sector-specific equity funds if they are concerned about margin calls during market corrections.
Reviewing a lender’s list of approved mutual fund schemes is essential, as some funds may not qualify for pledging.
Comparing interest rate offers based on the exact fund name and type ensures transparency in the borrowing terms.
The category of mutual fund you choose to pledge has a direct and measurable impact on the loan against mutual funds interest rate.
While debt funds offer more favourable terms due to their stability, equity and hybrid funds carry more risk and, therefore, attract higher borrowing costs. By carefully evaluating the fund type, the LTV ratio, and associated charges, investors can make informed decisions and access liquidity without disturbing their long-term financial plans.
Using a loan against mutual funds smartly allows you to meet immediate financial needs while still benefiting from future growth—offering the dual advantage of liquidity and capital preservation.
