Risks of Loan Against Mutual Funds: 4 Things to Know Before You Pledge
When people hear the term Loan Against Mutual Funds, one of the first questions they have is whether there are any risks involved.
It's a fair question.
Borrowing against your investments can sound risky at first. After all, your mutual fund portfolio represents years of disciplined investing, and the idea of using it as collateral naturally raises concerns. What happens if the market falls? Can you lose your investments? Will you still earn returns? What if you can't repay the loan?
These are important questions, and every investor should understand the answers before making a borrowing decision. Like any financial product, it's designed for particular requirements and needs to be understood, since that can affect what you expect from it.
In this blog, we'll break down the key risks associated with a Loan Against Mutual Funds, explain when they can arise, and share practical ways to manage them so you can make an informed financial decision.
How Does a Loan Against Mutual Funds Work?
You pledge your mutual fund units to a lender. The lender marks a lien on these units, an encumbrance that restricts you from redeeming, switching, or transferring them. In exchange, you receive a loan or an overdraft facility, sized against the current value of your holdings. The pledged units remain invested throughout the tenure of the loan.
To understand more, see everything you need to know about loan against mutual funds.
Every risk below stems from one structural fact: your collateral is revalued daily, and its value is not fixed.
Risk 1: Your Eligible Limit Changes with the Market (Margin Call)
Your eligible limit is not fixed for the tenure of the facility. Lenders revalue your pledged units daily, based on the fund's NAV.
If the market declines, the NAV of your pledged fund falls, and your collateral value declines with it which in turn leads to drop in your eligible limit. Your outstanding loan amount does not automatically reduce to match. As a result, your loan-to-value ratio, the proportion your outstanding loan represents of your collateral's current value, rises above the permissible threshold.
Each fund category carries a different LTV ceiling.
| Fund Type | Typical LTV | RBI Ceiling |
|---|---|---|
| Equity mutual funds | 45-50% of NAV | Up to 75% |
| Debt mutual funds | 70-90% of NAV | No fixed cap |
When your LTV ratio exceeds the permissible threshold, the lender issues a margin call in loan against securities, requiring you to either pledge additional units or repay part of the outstanding amount to restore the required ratio. Lenders typically allow 7 to 10 working days to comply, though this varies by lender and is specified in the loan agreement.
Here's what that looks like with real numbers.
| Particulars | Before Market Decline | After 12% NAV Decline |
|---|---|---|
| Pledged fund value | ₹4,00,000 | ₹3,52,000 |
| Eligible limit (50% LTV) | ₹2,00,000 | ₹1,76,000 |
| Amount drawn | ₹2,00,000 | ₹2,00,000 |
| Margin shortfall | — | ₹24,000 |
A 12% correction isn't unusual for equity markets. On a ₹4 lakh pledge, that's sufficient to create a ₹24,000 margin shortfall. You would need to repay this shortfall or pledge additional units within the stipulated window.
Debt fund NAVs are considerably less volatile than equity fund NAVs, which is why they carry a higher LTV ceiling. If your pledge is concentrated in equity, or in a single sector fund, your margin call exposure is concentrated accordingly. A pledge diversified across equity and debt holdings produces a more stable blended LTV.
Risk 2: Pledged Units Cannot Be Redeemed Until Loan Repayment
When you pledge your mutual fund units for a Loan Against Mutual Funds, they are marked under lien. This means you cannot redeem, switch, or sell those pledged units until the loan is repaid in full and the lender releases the lien.
This is an important consideration if you think you may need access to those investments during the loan tenure. While your ownership of the mutual funds remains unchanged, your ability to transact in the pledged units is temporarily restricted.
If you continue investing in the same mutual fund through SIPs, the newly purchased units are generally not automatically added to the lien. As a result, your folio may contain both pledged and unpledged units. This is often misunderstood, with some investors assuming their entire holding is under lien, while others overlook the unpledged units that remain available for redemption.
Risk 3: Default Triggers Redemption You Don't Control
If you fail to meet a margin call, or default on repayment, the lender is entitled to redeem your pledged units to recover the outstanding amount. Two consequences follow that borrowers typically don't anticipate.
You do not control the timing of redemption. If the lender redeems during a market downturn, the loss is realised at the point your fund's NAV has already declined, with no discretion available to you on timing.
You do not control which units are redeemed. Your folio may hold units purchased at different times, some qualifying for long-term capital gains treatment, others still classified as short-term. The lender determines the redemption sequence based on recovering the outstanding amount, not on optimising your tax position. Since any redemption, forced or voluntary, is treated as a sale for capital gains purposes, a default can result in a tax liability in addition to the loss of the units.
Risk 4: Fund Eligibility Is Lender-Specific and Subject to Change
Lenders maintain an approved list of eligible schemes. Not every mutual fund you hold will feature on it.
Thematic funds, sectoral funds, and international funds might be excluded, or accepted at a significant haircut to their NAV. Newer schemes without an established track record may face similar exclusion. ELSS units cannot be pledged during their mandatory three-year lock-in, and closed-ended schemes are excluded entirely, since they cannot be redeemed on demand.
Don't assume portfolio-wide eligibility at a uniform rate. Verify eligibility fund by fund. See loan against mutual funds eligibility for what lenders typically assess.
Few Risks Missed:
- If the fund undergoes a merger or reclassification
- Interest fluctuations
- Scheme delisting
- Loss of the Exit Option
How to Reduce the Risk of a Loan Against Mutual Funds
- Don't draw against your full eligible limit. Restricting your drawdown to 70-80% of the sanctioned limit creates a buffer before a market decline triggers a margin call.
- Diversify the pledge across equity and debt. Debt fund NAVs are more stable, which steadies your blended LTV.
- Monitor your NAV and eligible limit directly, rather than waiting for lender notification. Most digital LAMF platforms display this in real time.
- Set a self-imposed repayment schedule, even where the facility carries no mandatory EMI.
- Reconfirm eligibility and terms at each renewal. Don't assume this year's sanction terms carry forward automatically.
Final Thoughts
A Loan Against Mutual Funds is not a risk-free borrowing option, but it is also not as risky as it is often perceived to be. Most of the risks can be managed with responsible borrowing, regular monitoring of the Loan-to-Value (LTV) ratio, and a clear understanding of how the facility works.
Understanding the risks before borrowing is just as important as understanding the benefits. An informed borrowing decision also involves choosing a lender that provides transparency and keeps borrowers informed throughout the loan tenure.
Mirae Asset Financial Services offers a fully digital Loan Against Mutual Funds facility with transparent loan terms, real-time LTV visibility, and timely margin call alerts. This helps borrowers stay informed about their loan position and take timely action whenever required.
Things You Should Know About Risks of Loan Against Mutual Funds
No. RBI's end-use restrictions prohibit deploying LAMF proceeds for capital market investment, including purchasing shares, IPO subscriptions, or margin trading.
Equity mutual funds typically receive 45-50% of NAV, within an RBI ceiling of up to 75%. Debt mutual funds typically receive 70-90% of NAV, since RBI has not prescribed a fixed cap for this category.
It depends on your holdings, tax position, and repayment timeline. See loan against mutual funds vs personal loan for a detailed comparison.
Not necessarily. Many LAMF facilities carry a floating rate linked to the lender's benchmark, and overdraft-style products may reprice at renewal. Confirm this with your lender before assuming a fixed rate.