When it comes to managing your investments, knowing whether to take a loan against your mutual funds or liquidate them can be a game-changer. Liquidating mutual funds might provide immediate cash, but it disrupts your investments’ compounding growth and long-term potential.
On the other hand, opting for a loan against mutual funds allows you to access funds without selling your investments, ensuring they continue to grow and work towards your financial goals.
This decision can significantly impact your financial health, making it crucial to carefully weigh the pros and cons. Let’s explore how to make the right choice for your unique financial situation.
What is the Liquidation of Mutual Fund?
Liquidation of a mutual fund means selling your shares back to the fund and getting cash in return. It’s like cashing out your investment.
When you liquidate, the fund manager sells the underlying assets, and you receive the current market value of your shares. This can be a quick way to access funds, but it comes with potential downsides.
Things You Must Know About Liquidation of Mutual Fund
Immediate Cash: Liquidating provides immediate access to money, which can be crucial in an emergency.
Loss of Growth: Selling your shares means you miss out on future growth and compounding returns.
Tax Implications: Depending on how long you’ve held the investment, you might face capital gains taxes.
Market Timing: If you liquidate during a market downturn, you might sell at a loss.
What is a Loan Against Mutual Fund?
A Loan Against Mutual Funds is a financial arrangement in which investors use their mutual fund units as collateral to obtain a loan from a bank or financial institution.
This type of loan allows individuals to benefit from their investments without having to liquidate them. The mutual funds continue to generate returns, and the loaned amount can be used to meet immediate financial needs.
This financial instrument is especially useful for those who want liquidity without compromising their long-term investment strategy.
Things You Must Know Before Taking a Loan Against Mutual Fund
Interest Rates: Understand the interest rates associated with the loan, as they can impact your overall cost of borrowing.
Loan-to-Value (LTV) Ratio: Check the LTV ratio, which determines the amount you can borrow against the value of your mutual fund units.
Repayment Terms: Familiarize yourself with the repayment terms, including the tenure and any prepayment options.
Risk of Margin Calls: Be aware of the possibility of margin calls if the value of your mutual funds drops significantly, requiring you to top up the collateral or repay part of the loan.
Pros and Cons of Liquidation
| Pros of Liquidation | Cons of Liquidation |
| Immediate Access to Cash: Provides quick liquidity to meet urgent financial needs. | Loss of Future Gains: Sells off potential future income from investments. |
| Simplifies Financial Management: Reduces the complexity of managing multiple investments. | Possible Capital Gains Tax: Incurs capital gains tax on profits from the sale. |
| Potential Tax Benefits: Sometimes helps in optimizing tax liabilities if certain assets are sold. | Reinvestment Challenges: Finding suitable new investments can be tricky post-liquidation. |
| No Debt Incurred: Unlike loans, liquidation doesn’t involve borrowing and paying interest. | Market Timing Risks: Selling at the wrong time might lead to losses or reduced profits. |
| Reduces Market Risk Exposure: Frees you from potential future market volatility. | Penalties and Fees: Some investments have early withdrawal penalties or fees associated with liquidation. |
Pros and Cons of Taking a Loan Against Mutual Fund
| Pros of Loan against Mutual Fund | Cons of Loan Against Mutual Fund |
| No Need to Liquidate Investments: Allows you to retain ownership of mutual funds and continue earning returns. | Interest Costs: The loan comes with interest charges that can add up over time. |
| Quick Access to Funds: Provides liquidity without the need to sell assets. | Risk of Market Fluctuations: If the value of your mutual funds drops, it could affect your collateral. |
| Flexible Loan Amounts: The loan amount is based on the value of the mutual funds, offering flexibility. | Potential Loan Default: Defaulting on the loan could result in the loss of your mutual fund units. |
| Minimal Documentation Required: This usually involves less or no paperwork compared to other loans. | Potential Impact on Credit Score: Missing payments or defaulting can negatively impact your credit score. |
Factors to Consider While Making a Choice Between Loan Against Mutual Fund and Liquidation
To understand this better, let’s take a real-life example. Say there are two friends Priya and Rohan, both mutual fund investors.
Priya’s Scenario
Priya has mutual funds worth ₹5,00,000. She needs ₹2,00,000 urgently for her sister’s wedding. Instead of liquidating her mutual funds, she takes a loan against them. The bank offers her a loan at an interest rate of 9% per annum.
Market Scenario: The market is performing well, and Priya expects her mutual funds to grow at around 12% per annum.
Interest Rates: The 9% loan interest rate is lower than the expected 12% returns on her mutual funds.
Tax Implications: Priya can continue to benefit from the tax-efficient growth of her mutual funds. Additionally, the interest paid on the loan might be eligible for tax deductions.
Liquidity Needs: Priya gets the required ₹2,00,000 without disturbing her investment.
Repayment Capacity: Priya has a steady job and is confident she can repay the loan within a year.
By taking a loan against mutual funds, Priya meets her immediate financial needs while still benefiting from the growth of her investments.
Rohan’s Scenario
Rohan has mutual funds worth ₹5,00,000 and needs ₹3,00,000 to start a small business. He decides to liquidate a portion of his mutual funds.
Market Scenario: The market is highly volatile, and there’s uncertainty about future returns. Rohan prefers the security of having cash in hand.
Interest Rates: By liquidating his mutual funds, Rohan avoids paying 9% interest on a loan.
Tax Implications: While Rohan will incur a capital gains tax of 10% on the profit, he benefits from not having to pay ongoing interest on a loan.
Immediate Liquidity: Rohan instantly accesses the required ₹3,00,000 without any waiting period or approval process.
Financial Stability: Liquidation avoids the risk of loan default, which could harm his credit score and financial standing.
No Repayment Burden: By liquidating his mutual funds, Rohan does not have to worry about monthly loan repayments, thus easing his financial commitments.
Market Risk: Given the volatile market conditions, selling now might be more prudent than risking further potential losses if the market dips further.
Profit Potential: Rohan can use the ₹3,00,000 to start his business, which has the potential to generate significant profits, offsetting the capital gains tax he has to pay and providing a higher return on investment.
By choosing to liquidate his mutual funds, Rohan secures the funds he needs for his business venture, avoids the burden of loan interest, and mitigates the risks associated with a volatile market.
Comparing Banks: Loan Against Mutual Funds
| Features | HDFC Bank | SBI | Axis Bank | ICICI Bank |
| Facility Type (DL/OD) | Overdraft (with yearly renewal) | Overdraft (with yearly Auto Renewal/Review) | Overdraft (with yearly renewal) | Overdraft (with yearly renewal) |
| Processing Fee | Digital Amt – Rs 1499/- plus ST Physical Rs. 3500/- plus ST Enhancement (both Digital & Physical): Rs. 500 plus ST | New: 0.50% of Loan Amount with a minimum of Rs. 1000 +GST (Maximum Rs. 10,000/- + GST) Renewal (Yearly): Rs. 1000/- plus ST Processing Fee: Flat Rs. 1000/- under Festive Dhamaka valid till 31.03.25 | 0.50% of the loan amount or Rs. 2000/- whichever is higher plus GST Renewal: Equity: Rs. 3000/- plus GST Debt: 0.1% of the loan amount or Rs. 5000/- whichever is lower plus GST | 2% of the loan amount Renewal: Rs. 2500/- plus GST |
| Interest Rate (in %) | Avg IRR from July 24 to Sept 24: Equity- 10.59% Debt: 10.08% | 10.05% (Festive Dhamaka valid till 31.03.25) | Digital: 11.49% Pphysical: 11.50 -13.75 % *Interest Reset: Quarterly or As decided by the Bank, whichever is earlier | 6.50% – 19.50% (applicable for 1st July 24 to 30 Sept 24) |
| Tenure | 12 months | 12 months | 12 months | 12 months |
| Min/ Max Loan Amount | Min: Rs.50,000/- Max: Equity MF: Rs. 29 Lacs Debt MF: Rs. 1 Crore | Min: Rs. 25,000/- Max: Equity MF: Rs. 10 Lacs Debt MF: Rs. 5 crore | Equity MFs: Min: Rs. 25000/- Max: Rs. 20 lacs Debt /FMPs: Min: Rs. 1 lacs Max: Rs. 25 crore | Equity MFs: Min: RS. 50,000/- Max: Rs. 20 Lacs Debt/ETF/FMPs: Min: Rs. 50,000/- Max: no upper limit |
| Loan to Value (LTV) | Equity MF – 50% Debt MF- 80% | Equity/Hybrid/ETF- 50% Debt/FMP: 75% | Equity: 60% Debt: 85% | Equity: 50% Debt: 80% |
| Prepayment penalty | Nil | Nil | Nil | Nil |
Wrapping Up
Choosing between liquidating your mutual funds and taking out a loan against them is like selecting the best tool for the job. Every decision carries its pluses and minuses. Whether you’re looking for quick cash or long-term planning, the key is to stay aligned with your personal goals and finances.
In this article, we have thoroughly discussed the specifics of each option and the potential impact your decision will have on your financial journey and future goals. Making informed decisions keeps you on track, ensuring that you can manage both current needs and future ambitions effectively. Take your plunge wisely!
FAQs
What happens if the value of my mutual funds drops after taking a loan against them?
If the value of your mutual funds drops significantly, the lender might issue a margin call, asking you to top up the collateral or repay a portion of the loan to maintain the required loan-to-value ratio.
Can I take multiple loans against different mutual funds?
Yes, you can take multiple loans against different mutual funds, but each loan will be subject to the terms and conditions set by the respective lender.
Is there a limit to how much I can borrow against my mutual funds?
The amount you can borrow is typically a percentage of the value of your mutual funds, often ranging from 50% to 80%, depending on the lender’s policies and the type of mutual funds.
How long does it take to receive funds after liquidating mutual funds?
The time can vary based on the mutual fund company, but typically it takes 3-7 business days for the funds to be credited to your account.
What happens if I default on my loan against mutual funds?
If you default, your bank has the right to liquidate your mutual fund units to recover the outstanding loan balance. This could expose you not only to the Bank’s default penalty but also to distressed selling of the underlying assets. Most importantly, it hurts your credit score.
Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as a recommendation or investment advice by Equentis – Research & Ranking. We will not be liable for any losses that may occur. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL & certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.
I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.
