Is loan against a mutual fund preferable to a redemption

Is loan against mutual fund preferable to a redemption?

Financial management is one of the critical aspects of managing a good lifestyle. It is a common phenomenon that people face financial constraints or requirements for addressing the needs and desires of the family, contingencies, etc.

In such cases, one of the common practices is to target the investments and reserves for addressing the current financial requirements.

Both choices have advantages and disadvantages. The decision one makes depends on the personal financial situation, investment objectives, available funds, and other factors specific to the situation. The most important consideration when considering a loan against mutual funds or redemption is the effect it will have on ongoing long-term or retirement savings.

It has long been a question for borrowers to decide if they should be mortgaging their mutual funds and take a loan against it or redeem their fund value when in need of liquidity. 

What impact does each option have on the portfolio? And which one is the better choice? Read on to find out.

A quick loan against mutual fund shares is considered a cash equivalent transaction and may result in tax implications for the individual receiving the funds in some nationalities. Abhiloans recommends that it is important to consult financial advisors to have accurate compliance information.

On the other hand, redeeming the mutual fund shares results in a taxable event. Although borrowing from a bank or another financial institution may offer lower borrowing costs than the redemption of mutual funds.

While redeeming a mutual fund abruptly or before its tenure  (for lock in funds) may not result in loss of the invested principal, there is a chance of losing out on any gains made on the investment because of the premature or sudden redemption. 

For example – if the principal was Rs.10,000/- and the gains were Rs.1,250/-, the principal of Rs.10,000/- may not see a depreciation. However, the chances of getting the entire sum of Rs.1,250/- could be lesser or the final amount of gains made could probably decrease at the time of redemption.does not involve loss of principal investment, it does result in the loss of all accumulated gains. 

Furthermore, redeemed shares are not reinvested in the same fund and the investor will incur transaction costs to sell the fund holdings and purchase new funds with similar objectives and/or characteristics.

When it comes to taking a loan, a borrower should bear in mind the following:

  1. Redeem a mutual fund or use it as a collateral for a loan against mutual funds. 
  2. Financial experts recommend taking up instead of selling a mutual fund if the requirement is short term and can be repaid accordingly.
  3. Some mutual funds could have an exit load when redeemed before their maturity or in their lock-in period. This worry does not come into picture when the mutual fund or securities are pledged to borrow money.
  4. Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG) could be levied when equity funds are sold within 12 months. This applies to debt funds sold within 3 years. However, when a mutual fund is used as a collateral, these need not be sold which helps save on STCG and LTCG both.

Disruption of financial goals: 

An investor’s financial goals will be hurt if they redeem the mutual fund units. But if the investor takes out a loan against mutual fund units, their investments will continue to grow and will be able to reach their financial goals.

Benefits of keeping the mutual fund portfolio:

When investors take a loan on mutual fund units, they retain the investment portfolio. The increase in the units’ net asset value (NAV) will continue to build the portfolio. In addition to portfolio management, one can also keep getting dividends, if there are any, as and when they are paid out.

Other factors to consider when choosing between redemption and a loan against mutual funds include assessing your loan financial needs and finding the right financing institution like Abhiloans.