Loan against mutual funds or redeem? The break-even

The situation

You need ₹3 lakh for a year, perhaps a medical bill or a deposit on a flat, and you have ₹10 lakh in an equity fund. You can:

• Redeem ₹3 lakh, then rebuild the holding by investing a fixed amount every month for a year; or
• Borrow ₹3 lakh against the fund and repay it in 12 EMIs, leaving the fund untouched.

Both use the same monthly cash from your salary. What differs is whether that cash goes to a lender or back into the fund.

The loan

At 10.5% a year on the reducing balance, ₹3 lakh over 12 months is an EMI of ₹26,445, with total interest of ₹17,335. The effective annual rate is 11.02%, slightly above 10.5% because interest is charged monthly.

Who ends ahead after 12 months

Assume the redeem route invests ₹26,445 a month back into the fund, the same cash the loan route pays the lender. Compare what each has at the end of the year beyond the untouched ₹7 lakh:

The break-even is where the fund earns the loan's effective rate, about 11% a year. Below it, redeeming and rebuilding wins; above it, borrowing wins. The difference either way is small, a few thousand rupees on ₹3 lakh.

So the loan is a bet that the fund will beat about 11% over the next year. No one knows whether an equity fund will, and over a single year the range is wide.

What tilts it

Several real costs sit outside that table:

• Tax on redemption favours the loan. Units held under a year are short-term and taxed at 20%. If ₹3 lakh of redemption carries ₹1 lakh of short-term gain, that is ₹20,800 of tax with cess, which outweighs every row above. If the units are long-term and the gain fits within the ₹1.25 lakh yearly exemption, redemption costs no tax at all.
• An exit load favours the loan. A 1% load on ₹3 lakh is ₹3,000.
• Processing fees and charges favour redeeming. Lenders charge a fee and the registrar charges for marking a lien.
• Margin calls. If the fund falls 30%, a ₹10 lakh holding is worth ₹7 lakh, and a lender lending half the value would allow only ₹3.5 lakh. A deeper fall forces you to repay early or lose units at the bottom, exactly what the loan was meant to avoid.
• The loan must actually be repaid on schedule. If the EMIs slip, the comparison falls apart.

A short rule

• Redeem if the units are long-term with gains inside the exemption, there is no exit load, and you can live with the market moving while you rebuild.
• Borrow if redeeming would trigger short-term tax or an exit load, the need is short, and you have a clear plan to repay.

Either way, money needed within a year belongs in an emergency fund rather than equity. For other ways to borrow against what you own, see gold loan vs personal loan vs credit card.

Reading this

• The 10.5% rate, ₹3 lakh amount and fund returns are assumptions; lenders' rates, fees and loan-to-value limits differ.
• Fund returns are applied as a steady annual rate, compounded monthly for the SIPs; real returns are not steady.
• Tax figures assume the 20% short-term rate plus 4% cess for listed equity funds.