Loan Against Mutual Funds vs Loan Against Securities: Pros, Cons & Best Options

When making an investment, the primary goals typically include generating wealth, earning passive income, or securing one's financial future. Mutual funds are one of the most common investment options, and they can also be leveraged to avail a loan in times of need. However, many investors may invest in other assets such as equities, bonds, or ETFs. These, too, can be used as collateral for a loan. In this blog, we will compare loans against mutual funds versus loans against securities and determine which is the better option.

What is a Loan Against Mutual Fund (LAMF)?

A loan against a mutual fund is a loan in which your mutual fund units are pledged as collateral to secure a loan. Banks and financial institutions offer loans, which are a percentage of the mutual fund investment’s value.

Let’s look at an example of how a loan against a mutual fund works. An investor has a mutual fund investment worth ₹5 lakh. The investor pledges these mutual fund units against which the bank offers a loan of ₹4 lakh.

What is a Loan Against Securities?

A loan against securities is similar to a loan against mutual funds, but it encompasses a broader range of assets. A loan against securities is a type of loan that is offered against various assets, including stocks, bonds, exchange-traded funds (ETFs), mutual funds,  insurance policies, and even ESOPs.

Depending on eligibility and the loan-to-value (LTV) ratio, investors can avail themselves of a loan against eligible securities.

For example, an investor has shares of XYZ company worth ₹1 lakh. Depending on the lender, the investor can avail a loan of up to ₹50,000 on the shares.

Loan Against Mutual Funds vs Loan Against Securities – Side-by-Side Comparison Table

Pros and Cons of a Loan Against Mutual Funds

Pros

• Quick liquidity without redemption.
• Allows investors to stay invested.
• Minimum documentation
• Lower interest rates compared to personal loans

Cons

• The lender might liquidate your investments in the case of default
• Fluctuations in the NAV may impact the amount of money you can borrow
• It may not be suitable for borrowers seeking to borrow a large sum for an extended period.

Pros and Cons of Loan Against Securities

Pros

• Investors can retain ownership of the asset, allowing the investment to grow in value.
• Interest rates may be slightly lower than those for personal loans.
• Provides the borrower with easy access to liquidity without requiring the sale of the shares.

Cons

• Similar to LAMF, the lender may liquidate your holdings in the case of default.
• The loan-to-value (LTV) is typically 50-65% of the market value of the asset. However, it can range from 95% to 100% depending on the type of securities one is looking to use as collateral.
• Market risk can significantly impact the value of the investment, potentially leading the lender to request additional collateral if the investment's value declines substantially.

Differences Between Loan Against Mutual Funds and Securities 

As an investor, it is essential to understand the distinction between a loan against mutual funds and a loan against securities. Knowing the key differentiating factors can help you make informed decisions.

Eligible Assets

A loan against mutual funds is limited to the value of the mutual funds. Typically, lenders offer loans against equity, debt, and hybrid mutual funds. Loan against securities has a wider security pool and allows investors to borrow money against assets such as shares, bonds, mutual funds, and ETFs.

Loan-to-Value

The loan-to-value (LTV) ratio refers to the amount of the loan in relation to the value of the security. In the case of loans against mutual funds, lenders might offer loans of up to 70-85% of the invested value. Under loan against securities, the LTV varies depending on the asset classes, with the typical LTV being 50-65%. The LTV also differs from lender to lender.

Risk Factors

The primary risk factor for loans against mutual funds is the fluctuations in the net asset value (NAV). The NAV impacts the invested value, which in turn affects the amount of money you can borrow. The primary risk factor for loans against securities is market fluctuations, which impact the value of assets such as shares, bonds, and ETFs.

Which One Should You Choose

When considering a loan against mutual funds versus a loan against securities, it is important to consider certain factors before making a decision. Although both types of loans have certain similarities, a loan against a mutual fund offers slightly lower interest rates. Further, the maximum loan amount may be a limiting factor depending on the type of mutual fund.

A loan against securities can be more beneficial for investors who hold various securities that they wish to use as collateral for a loan. However, most lenders typically offer up to 65% of the asset's market value.

One should consider the processing fees and other charges of availing a loan. Comparing different lenders and loans can help you pick the most suitable option.