Quote From pm133:
There should be no issues as regards getting funding but the bigger concern is your mental health. I would always strongly recommend fixing this before you start a PhD because otherwise that could be a very serious problem for you later on. A PhD will expose and probably make worse any mental health problems you have.

Quote From Em89:
Always apply, you are 100% not going to get funding if you don't apply, applying gives you a chance! Many people will have suffered during the pandemic, and almost every academic I work with has stated their productivity has diminished. Make your cover letter really strong, highlight what has gone 'wrong' but don't dwell on it, and highlight how you overcome it. For instance if I had to write about my job performance it would be this:
'During the pandemic I experienced some anxiety with working in a very different way, initially this impacted my performance. However I have learnt so many new ways of working now, and new strategies that should I face sudden disruptions to work and life I am now well prepared, as evidenced by my ability to bring the research project up to date'
So you may have secured a merit instead of a distinction, but you still achieved a merit despite everything going on - you didn't give up, your grade didn't slip to a pass. Think about how much stronger you are as a person because you did your masters during a global pandemic, think about all the new strategies you've learnt, how you've found ways to overcome barriers. Turn this awful year into your biggest strength!
If you don't successfully get funding this time, try and get some research assistant work and try again next year. Remember it's not a race, it's a journey.
Best of luck