Loan Against Mutual Funds vs Selling Mutual Funds – Which Option Is Better?

When you need funds urgently, your mutual fund investments often become the first source of liquidity. At that point, investors usually face a common dilemma:
Should you sell (redeem) your mutual fund units or take a loan against mutual funds?Both options can help you access money, but they differ significantly in terms of cost, tax impact, flexibility, and long-term wealth creation. This guide breaks down both choices in detail to help you decide which option suits your situation better.

What is a Loan Against Mutual Funds?

A Loan Against Mutual Funds (LAMF) allows you to borrow money by pledging your mutual fund units as collateral to a bank or NBFC. Your mutual funds are not sold; instead, a lien is marked on the units.

Key points:

• You continue to own the mutual fund units
• Loan amount depends on the Loan-to-Value (LTV) ratio
• Equity funds: ~50–60%
• Debt funds: ~70–80%
• Interest rates are typically lower than personal loans
• Once the loan is repaid, the lien is removed

LAMF is commonly used for short-term liquidity needs without disturbing long-term investments.

What Does Selling (Redeeming) Mutual Funds Mean?

Selling mutual funds means redeeming your units and receiving the proceeds in your bank account. Once sold:

• Your investment value reduces permanently
• You stop earning returns on the redeemed amount
• You may have to pay capital gains tax

Redemption is straightforward and does not involve repayment obligations, but it can significantly impact long-term compounding.

Key Differences: Loan Against Mutual Funds vs Selling Mutual Funds

Parameter	Loan Against Mutual Funds	Selling Mutual Funds
Ownership	Units remain invested	Units are permanently sold
Liquidity	Loan disbursed quickly	Proceeds credited after redemption
Cost	Interest payable on loan	Opportunity cost of lost returns
Tax Impact	No tax on loan amount	Capital gains tax applicable
Long-Term Impact	Compounding continues	Compounding stops
Risk	Margin call if NAV falls	No market risk post-sale
Flexibility	Can repay anytime	One-time irreversible decision

Cost Comparison: Interest Cost vs Opportunity Cost

Loan Against Mutual Funds

• You pay interest on the loan amount
• Interest rates are usually lower than unsecured loans
• If markets perform well, returns may outpace interest cost

Selling Mutual Funds

• No interest cost
• However, you lose future growth and compounding
• Re-entering later may be costly if markets rise

Example:
Selling ₹5 lakh of equity mutual funds that could grow at 12% annually may cost you much more in the long run than paying 9–10% interest for a short-term loan.

Tax Implications

Tax Treatment of Loan Against Mutual Funds

• Loan amount is not taxable (it is not income)
• No capital gains tax since units are not sold
• Interest is generally not tax-deductible for personal use

Tax Treatment of Selling Mutual Funds

Capital gains tax applies based on fund type and holding period:

Equity Mutual Funds

• Short-term (≤ 12 months): 15%
• Long-term (> 12 months): 10% on gains above ₹1 lakh

Debt Mutual Funds

• Taxed as per slab rate (as per current rules)

If mutual funds are sold to repay a loan (voluntarily or due to default), capital gains tax will apply at that time.

Impact on Long-Term Investment Goals

Selling mutual funds interrupts compounding, which is critical for wealth creation. Once sold, that capital no longer participates in market growth.

In contrast, a loan against mutual funds:

• Allows you to stay invested
• Preserves long-term financial goals (retirement, education, wealth creation)

Is more suitable when liquidity needs are temporary.

When Should You Choose a Loan Against Mutual Funds?

A loan against mutual funds may be a better choice when:

• You need short-term liquidity
• You expect to repay the loan soon
• You want to avoid selling long-term investments
• Loan interest is lower than expected investment returns
• You are confident in managing market volatility

When Does Selling Mutual Funds Make More Sense?

Selling mutual funds may be more appropriate when:

• You no longer want exposure to those funds
• You are rebalancing your portfolio
• The funds are underperforming or misaligned with goals
• The loan interest cost outweighs potential returns
• You need funds permanently, not temporarily

Risks and Considerations for Both Options

Loan Against Mutual Funds

• Risk of margin calls if NAV falls
• Lender may sell units if LTV breaches limits
• Requires monitoring and repayment discipline

Selling Mutual Funds

• Risk of poor market timing
• Permanent loss of future returns
• Tax outflow reduces net proceeds

Which Option Is Right for You?

Choose Loan Against Mutual Funds if:

• Your need is short-term
• You want to preserve investments
• You can manage repayment and volatility

Choose Selling Mutual Funds if:

• Your financial need is long-term or permanent
• You want to exit a fund anyway
• You prefer zero repayment obligations

The decision should be aligned with your time horizon, tax impact, market outlook, and financial goals.

Conclusion

Both Loan Against Mutual Funds and Selling Mutual Funds can provide liquidity—but the long-term impact is very different.
Selling mutual funds gives immediate cash but can hurt long-term wealth creation and trigger taxes. A loan against mutual funds helps you stay invested but requires disciplined repayment and monitoring.

The right choice depends on how long you need the money, your ability to repay, and your investment goals. Understanding these trade-offs can help you make a smarter, more informed financial decision.