Top 10 Mistakes Borrowers Make While Taking a Loan Against Mutual Funds

Building a robust financial strategy often involves finding the right balance between long-term growth and immediate liquidity. For many investors, a Loan Against Mutual Funds (LAMF) offers a sophisticated way to access capital without disrupting their wealth creation journey. However, because this product sits at the intersection of credit and market investments, it requires a nuanced approach. To manage LAMF better, one must understand that it is more than just a quick cash withdrawal; it is a strategic leverage tool.

When handled correctly, LAMF provides a safety net that keeps your SIPs and compounded returns intact. When handled poorly, it can lead to unnecessary costs or, in extreme cases, the forced liquidation of your assets during a market downturn. By identifying common LAMF mistakes to avoid, you can ensure that your borrowing serves your financial goals rather than hindering them.

Top 10 Mistakes Borrowers Make While Taking a Loan Against Mutual Funds

Navigating the landscape of asset-backed lending requires diligence. Most errors stem from a lack of clarity regarding the terms or a failure to account for market volatility. Below are the top ten mistakes that borrowers frequently make and how you can sidestep them to manage LAMF better.

1. Over-Leveraging Your Portfolio

One of the most common LAMF mistakes to avoid is borrowing the absolute maximum amount permitted by the lender. While equity funds typically allow a Loan-to-Value (LTV) of up to 50% and debt funds up to 70-80%, utilizing the full limit leaves no room for error. If the market drops, your LTV will spike, potentially triggering a margin call.

• The Risk: A sudden 10% market correction could force you to pledge more units or pay back a portion of the loan instantly.

• The Solution: Aim to keep your utilization at 60-70% of the sanctioned limit to provide a buffer against market swings.

2. Using the Loan for Non-Essential Lifestyle Spends

A loan against your investments should ideally be a bridge for emergencies or productive capital, not a source for luxury purchases. Using LAMF to fund a vacation or a high-end gadget is a strategic error because you are essentially putting your long-term wealth at risk for a depreciating asset. To manage LAMF better, prioritize using the funds for medical emergencies, business expansion, or debt consolidation.

3. Ignoring the Specific Fund Eligibility

Not all mutual funds are eligible for a lien. Borrowers often assume their entire portfolio is available for a loan, only to find out that their Sectoral, Small-cap, or ELSS funds (within the lock-in period) are excluded.

4. Failing to Compare Interest Rates and Processing Fees

Since LAMF is a secured product, interest rates are significantly lower than personal loans, usually ranging between 9% and 11%. However, many borrowers stick with their primary bank without checking digital-first platforms that might offer more competitive rates or zero processing fees. To manage LAMF better, always compare the "Total Cost of Borrowing," which includes:

• Processing fees (can range from ₹500 to 1% of the loan).

• Annual renewal charges for the overdraft facility.

• Lien marking charges levied by the RTA (CAMS/KFintech).

5. Neglecting the Impact of Market Volatility (The Margin Call)

Unlike a home loan, where the collateral value is stable, the collateral in LAMF, your mutual fund NAV, changes daily. Many borrowers forget that if the value of their pledged units falls below a certain threshold, the lender will issue a margin call. One of the critical LAMF mistakes to avoid is ignoring NAV alerts. If you cannot fulfill a margin call within the stipulated 24-48 hours, the lender has the right to sell your units at market lows to recover the difference.

6. Treating the Overdraft as Permanent Capital

LAMF is usually structured as an overdraft (OD) facility. This means you only pay interest on what you use. However, some borrowers treat this like a "perpetual fund" and never plan for the principal repayment. This leads to a long-term interest burden that can eat into the CAGR of your mutual funds. A disciplined borrower uses the OD for short-term needs and repays the principal as soon as cash flow allows.

7. Overlooking the Tax Implications

While taking a loan against mutual funds is not a taxable event (unlike selling funds, which triggers Capital Gains Tax), the interest you pay on the loan is generally not tax-deductible if used for personal expenses. However, if the funds are used for business purposes, you might be able to claim the interest as a business expense. Failing to consult a tax expert can lead to missed opportunities or unexpected liabilities.

8. Not Having a Solid Repayment Strategy

Borrowing is the easy part; servicing the debt is where many falter. Before pledging your units, you must have a clear map of where the repayment will come from. Relying on "future market gains" to pay off the loan is a dangerous gamble. To manage LAMF better, ensure your monthly income or business cash flows can comfortably cover the interest payments even if the market remains stagnant.

9. Pledging the Wrong Type of Funds

If you have a mix of debt and equity funds, choosing which to pledge is a strategic decision. Debt funds offer higher LTV and lower interest rates but lower growth potential. Equity funds offer lower LTV but higher potential for the "Spread" (the difference between your fund's returns and the loan's interest rate).

• Pro-Tip: If you need a larger amount, pledge debt funds first.

• Pro-Tip: To keep costs low, debt funds are usually the better option for collateral.

10. Forgetting to Remove the Lien Post-Repayment

The process isn't over when the balance hits zero. Many borrowers forget to follow up with the lender to initiate the "Lien Revocation" with the RTA. Until the lien is removed, you cannot sell or switch those units. To manage LAMF better, ensure you receive a formal closure letter and verify that your units are "Free" on the CAMS or KFintech app shortly after closing the loan.

How to Manage LAMF Better: A Strategic Checklist

To ensure you stay on the right side of the wealth-building equation, follow this streamlined checklist. Implementing these steps will help you internalize the best LAMF mistakes to avoid and maintain a healthy financial profile.

• Maintain a Diversified Portfolio: Do not pledge your entire portfolio to a single fund house. Diversifying your collateral across 2-3 fund houses reduces the risk of administrative delays.

• Monitor the Interest-to-Growth Ratio: If your mutual fund is growing at 12% and your loan interest is 10%, you are still gaining 2% on "borrowed money." If the fund growth drops below the interest rate for a prolonged period, consider prepaying the loan.

• Use Digital Platforms for Speed: Traditional banks may take 5-7 days for lien marking. New-age platforms can often disburse funds within hours, which is vital during emergencies.

• Automate Interest Payments: Ensure your linked bank account has a sufficient balance for the monthly interest servicing to avoid "Bounce Charges" which can be as high as ₹500 - ₹1200.

Conclusion

A Loan Against Mutual Funds is one of the most efficient liquidity tools available to modern investors. It allows you to stay invested in the market while meeting your immediate cash requirements. However, the key to success lies in discipline. By being mindful of the LAMF mistakes to avoid, such as over-leveraging or ignoring market volatility, you can manage LAMF better and ensure your assets continue to work for you.

If you are looking for a seamless, transparent, and digital-first way to unlock the value of your investments, it is time to explore modern solutions. Visit discvr.ai to explore how our Loan Against Mutual Funds (LAMF) product can provide you with instant liquidity at competitive rates, ensuring your financial journey never hits a roadblock.