Before selling your ELSS, check if borrowing makes more sense

Equity Linked Savings Schemes (ELSS) remain a favored investment choice among Indian taxpayers due to their tax benefits under Section 80C and potential for equity-linked returns. However, the mandatory three-year lock-in period restricts investors from accessing their funds during this duration, even in emergencies.

Recently, various banks, non-banking financial companies (NBFCs), and fintech platforms have introduced facilities allowing investors to borrow against their ELSS units after the lock-in period ends, without requiring redemption. This option provides an alternative to selling the units, allowing investors to maintain their tax benefits and stay invested in the market.

Understanding ELSS Lock-In and Borrowing Options

ELSS investments are composed of units each subject to its own three-year lock-in starting from the purchase date. Investors using systematic investment plans may thus hold a mix of locked and loan-eligible units simultaneously.

Once units have completed the lock-in, investors can pledge them as collateral through a process called “lien-marking,” facilitated by mutual fund registrars like CAMS or KFintech, typically confirmed digitally. Lenders then offer a credit line based on a loan-to-value (LTV) ratio that usually ranges from 50% to 75% for equity funds such as ELSS, varying by institution.

Loan Amounts, Disbursements, and Interest Rates

For example, an investor with ₹5 lakh in unlocked ELSS units might access a loan amount between ₹2.5 lakh and ₹3.75 lakh. Loan disbursements can vary from small sums to several crores, with funds credited within hours to a few business days.

Interest rates on these loans generally range between 10% and 11% annually, notably lower than unsecured personal loans or credit card rates.

Benefits of Borrowing Against ELSS Units

Importantly, pledging ELSS units does not constitute a sale, so it does not trigger long-term capital gains tax or revoke previously claimed Section 80C deductions. Investors continue to receive dividends and potential capital appreciation while the loan is active.

Some lenders promote these loans as a way to finance additional ELSS investments annually by pledging older units, thus maintaining tax-saving compliance without liquidating holdings.

Risks and Considerations

Nevertheless, borrowing against ELSS carries risks. Market downturns may reduce the pledged units’ value below the lender’s comfortable threshold, prompting margin calls that require loan repayment or additional collateral.

Persistent defaults can lead lenders to liquidate pledged units to recover the loan, potentially incurring capital gains taxes and losses if the market is unfavorable. During the loan, pledged units cannot be sold or reallocated until the debt is fully repaid.

Policy Variations and Eligibility

Policies for ELSS-backed loans vary among financial institutions. Some, like Smallcase, currently exclude ELSS from their loan offerings even after the lock-in expires, while others accept ELSS units subject to eligibility and an approved fund list.

Investors considering borrowing against ELSS should carefully compare lenders’ terms, including interest rates, LTV ratios, and eligibility conditions, to determine if this option suits their financial needs compared to redeeming their units.

Frequently Asked Questions

  • Can an investor pledge ELSS units as collateral before the three-year lock-in ends?
    No; pledging is only permitted after the mandatory lock-in period is over.
  • How is the loan amount against ELSS units determined?
    The loan amount depends on the lender’s loan-to-value policy and the current net asset value of the unlocked ELSS units.

Key Takeaways

  • ELSS offers tax benefits but has a mandatory three-year lock-in period restricting fund access.
  • Borrowing against ELSS units after lock-in allows maintaining tax benefits without selling units.
  • Loans are based on loan-to-value ratios, typically 50%-75%, and have lower interest rates than unsecured loans.
  • Pledging units does not trigger capital gains tax or affect Section 80C deductions.
  • Borrowing carries risks, including margin calls and potential forced liquidation of units.
  • Lending policies vary; investors should compare terms before opting for a loan against ELSS.