Why Some Mutual Funds Are Ineligible for Loans

Investors often view their mutual fund portfolios as liquid gold, a reservoir of wealth that can be tapped into during financial emergencies. The mechanism of lending against securities has gained immense popularity because it allows individuals to access capital without disrupting their long-term compounding journey. 

However, a common point of friction arises when investors discover that not every unit in their folio can be used as collateral. While a loan against mutual funds is a streamlined process, certain regulatory, structural, and risk-based constraints make specific funds ineligible for this facility.

The eligibility of a fund is not just a matter of its market value; it involves a complex interplay of Asset Management Company (AMC) tie-ups, the nature of the underlying assets, and the internal risk mandates of the lending institution. 

For an enterprise-grade understanding of why your request for lending against securities might be turned down, we must look closer at the criteria that govern these financial products and the specific ineligible MF schemes that often catch borrowers off guard.

The Role of Approved Lists in Loan Against Mutual Funds

Every bank and Non-Banking Financial Company (NBFC) maintains a rigorous "Approved List of Securities." This list is the primary filter for a loan against mutual funds. If a particular scheme does not feature on this list, the lender will not accept it as collateral, regardless of how well the fund is performing. 

These lists are reviewed periodically, often quarterly or even monthly, to account for changes in market volatility, scheme AUM, and fund management quality.

Lenders curate these lists based on the liquidity of the fund and the reputation of the AMC. Most major lenders prefer funds registered with Computer Age Management Services (CAMS) or KFintech, as these Registrar and Transfer Agents (RTAs) facilitate seamless digital lien marking. 

If your fund belongs to a smaller AMC with an AUM of less than 20 crores or an RTA that isn't integrated with the lender’s platform, it remains outside the scope of lending against securities.

Primary Factors for Fund Exclusion

Why ELSS and Lock-in Periods Create Ineligibility

One of the most frequent reasons for ineligibility in lending against securities involves tax-saving instruments. Equity Linked Savings Schemes (ELSS) are a favorite among Indian investors for their Section 80C benefits. 

However, these funds come with a mandatory three-year lock-in period. During this window, the units are legally "frozen" and cannot be transferred, redeemed, or pledged. These are among the most common ineligible MF schemes encountered by retail borrowers.

Until the three-year duration from the date of investment (for each SIP installment) is complete, these units cannot be used for a loan against mutual funds. Even post-lock-in, some lenders may still hesitate to include certain ELSS funds if they do not meet other internal risk parameters. 

Understanding this "temporary ineligibility" is crucial for tax-conscious investors who might need liquidity and are looking for eligible mutual funds for loan options within their existing portfolios.

Structural Constraints Impacting Eligibility

Closed-Ended Schemes

Unlike open-ended funds that allow daily entry and exit, closed-ended schemes have a fixed maturity period. Many financial institutions avoid these for lending against securities because the exit route is restricted. 

Since these units cannot be redeemed at the will of the lender during the loan tenure, they pose a liquidity risk. If a borrower defaults, the lender may be stuck holding the units until the maturity date, which is a situation most banks and NBFCs prefer to avoid.

Minor Folios

Investments held in the name of a minor are almost universally ineligible for a loan against mutual funds. This is due to the stringent legal complexities surrounding the protection of a minor's assets. 

Legally, a guardian cannot pledge a minor’s property for personal debt. Because the RTA and lenders cannot verify that the loan is being used for the direct benefit of the minor, these units are excluded from lending against securities to prevent future litigation.

Pledged Units

A fundamental rule of lending against securities is that the asset must be "unencumbered." If you have already marked a lien on certain units for an existing bank guarantee or a previous credit line, those units are legally frozen. 

You cannot "double-dip" by using the same units for a secondary loan against mutual funds. Only "free" units that appear as unpledged in your Consolidated Account Statement (CAS) are eligible for fresh credit.

Joint Holding Patterns

Digital platforms for a loan against mutual funds thrive on speed and automation. If your units are held in joint names, specifically under a "Jointly" mandate, they are frequently excluded. In such cases, every action requires the physical or digital signature of all holders. 

Most lenders find this too cumbersome for automated lending against securities and prefer "Single" or "Either or Survivor" accounts, where a single primary holder can authorize the pledge seamlessly.

Risk Management and the LTV Ratio

Lenders are essentially risk managers. When they facilitate a loan against mutual funds, they must ensure that the collateral is stable enough to cover the loan amount even during a market crash. This is where the Loan-to-Value (LTV) ratio plays a critical role. Typically, equity funds have an LTV of 50%, while debt funds can offer much higher leverage, often up to 80% or 85%, depending on the lender.

If a fund is deemed too "risky" or "volatile," the lender may decide to exclude it entirely rather than offering a very low LTV. For instance, small-cap funds or sectoral funds (like Pharma or Tech) are often the first to be removed from approved lists during periods of extreme market uncertainty. For a successful loan against mutual funds experience, identifying eligible mutual funds for a loan typically leads investors toward large-cap, hybrid, or liquid debt funds.

Single-Scheme Concentration

Lenders operate on the principle of risk mitigation. If your entire investment portfolio is concentrated in a single niche or thematic fund, it presents a significant concentration risk. 

For instance, if you only hold a sector-specific fund like Digital Technology or Infrastructure, a downturn in that specific industry could crash your collateral value overnight. 

To protect themselves, financial institutions often reject a loan against mutual funds application if the borrower lacks diversification. They prefer a spread across different asset classes or diversified equity funds to ensure the security remains stable.

Penny Stocks in Portfolio

The "health" of a mutual fund is determined by its underlying holdings. If a fund manager has invested heavily in low-quality, small-cap, or illiquid "penny stocks," the fund itself may be blacklisted by lenders.

In the context of lending against securities, liquidity is king. If the lender ever needs to liquidate your units to recover a default, they need to be sure the underlying stocks can be sold without causing a price collapse. 

Funds with "junk" holdings are viewed as high-risk and are rarely eligible for a loan against mutual funds.

Frequent Manager Changes

Stability in fund management is a key metric for institutional due diligence. If a mutual fund experiences rapid turnover in its leadership or fund management team, it can lead to inconsistent strategies and volatile returns. 

During the vetting process for lending against securities, lenders flag these funds because they lack a long-term, reliable track record. 

A fund in constant flux is seen as an unpredictable asset, often leading to its exclusion from the approved list for a loan against mutual funds.

Operational Hurdles: The CAMS and KFintech Factor

In the modern digital lending ecosystem, speed is a competitive advantage. Most fintech platforms offering lending against securities rely on "Instant LAMF" processes. 

These processes require the RTA (Registrar and Transfer Agent) to verify and mark a lien on the units in real-time. If a fund is not part of this digital pipeline, it effectively joins the list of ineligible MF schemes for online applications.

If your mutual fund units are held in physical form or through a platform that doesn't share data seamlessly with the lender’s ecosystem, they become effectively ineligible for an instant loan against mutual funds. 

While you can technically convert them to demat or update your records, the immediate ineligibility often surprises investors. To ensure you have eligible mutual funds for a loan, it is best to hold them in a single-name folio with updated KYC.

Common Operational Roadblocks

1. Name Mismatch: If the name on your PAN card does not match the name in your mutual fund folio, the lien marking for lending against securities will fail.

2. Joint Holding Issues: In many cases, if the second holder has not provided consent or is not part of the loan application, the units cannot be pledged for a loan against mutual funds.

3. Missing Contact Details: Folios without a verified email or mobile number cannot receive the OTP required for the digital pledge in lending against securities.

Regulatory Compliance: RBI and SEBI Mandates

The Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) provide the overarching framework for lending against securities. These regulators mandate that banks cannot exceed certain exposure limits to the capital markets. 

If a bank has already hit its "ceiling" for lending against equity, it might stop accepting new equity mutual fund pledges, making those funds temporarily ineligible. As of late 2025, RBI has revised loan limits for certain categories, increasing the cap for debt mutual funds to 1 crore for individuals in some cases.

Furthermore, RBI guidelines prevent lending against securities for speculative purposes. If the lender suspects the funds will be used to buy more stocks (margin trading), they can deny the loan against mutual funds. 

Compliance with "Know Your Customer" (KYC) norms is also non-negotiable; an "Incomplete KYC" status or a "KYC Registered" status that hasn't been validated is a primary reason for fund ineligibility.

Regulatory Checkpoints for Eligibility

Strategic Tips to Ensure Your Funds Qualify for Loans

To maximize your chances of securing a loan against mutual funds, it is wise to curate your portfolio with eligibility in mind. Identifying eligible mutual funds for a loan before you need the capital is a proactive step. 

Opting for reputable AMCs and ensuring your units are in a digital format are the first steps toward a seamless experience in lending against securities.

Diversification is not just a strategy for returns; it is a strategy for liquidity. By spreading your investments across large-cap, mid-cap, and debt instruments, you ensure that at least a significant portion of your portfolio remains eligible for lending against securities even if one sector or fund house faces a temporary setback or is moved to the list of ineligible MF schemes.

Improving Your Eligibility Profile

• Consolidate Folios: Use a single PAN and ensure your contact details are updated across all folios for a smooth loan against mutual funds application.

• Prefer Growth Options: Some lenders find it easier to value and lien-mark "Growth" variants compared to "IDCW" (Income Distribution cum Capital Withdrawal) options.

• Monitor Approved Lists: Before relying on a fund for an emergency loan against mutual funds, check if your lender still carries it on their approved scrip list.

Conclusion

While the concept of a loan against mutual funds is straightforward, the underlying mechanics of eligibility are designed to protect both the lender and the financial system's stability. Ineligibility is rarely a reflection of a fund's quality, but rather a reflection of its liquidity, regulatory status, or operational compatibility. 

Identifying eligible mutual funds for loan and steering clear of common ineligible MF schemes allows you to treat your investments as a flexible credit line. By understanding these nuances, you can better prepare your portfolio for lending against securities when the need arises.

If you are looking for a seamless, transparent, and high-value experience for your financial needs, explore the possibilities with discvr.ai. Their advanced LAMF product is designed to bridge the gap between your investments and immediate liquidity, ensuring you get the most out of your portfolio with minimal hurdles.