Loan Against Mutual Funds vs Redemption: Which Should You Choose?

When you need urgent funds, one of the biggest dilemmas is whether to liquidate your investments or borrow against them. Mutual funds are a common investment choice, but the question often arises: Should you redeem your mutual fund units or take a loan against them? A loan against mutual funds (LAMF) lets you borrow without disturbing your portfolio, while redemption gives you instant liquidity but at the cost of losing potential future gains. Both approaches have pros and cons, and the right choice depends on your financial goals, urgency, and repayment ability.

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What is a loan against mutual funds (LAMF)?

A loan against mutual funds (LAMF) is a secured credit facility that allows you to pledge/lien-mark your mutual fund units as collateral in exchange for funds. Instead of selling your investments, you continue to hold them, and they may still generate potential returns. You can borrow against both equity and debt mutual funds, often at competitive interest rates, and use the funds for any urgent need like education, healthcare, or business expenses.

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What is redemption and how does it work?

Redeeming mutual funds means selling your fund units back to the fund house in exchange for money. This is a straightforward process, but it comes with implications like potential loss of future gains. Key points to understand redemption:

• Process: Redemption requests can be made online or offline, and the amount is usually credited within 1–3 working days.
• Exit load: Some schemes charge an exit load if redeemed before a minimum period.
• Impact on future goals: You lose the benefit of compounding and future growth when you sell your investments.

LAMF vs redemption - Quick pros and cons

Here are the differences between loan against mutual funds and mutual fund redemption.

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Why is loan against mutual funds a good option compared to other loans?

When compared to unsecured loans, a loan against mutual funds often proves more beneficial. Reasons to choose LAMF over other loans:

• Lower interest rates: Since it is secured, interest rates are more affordable.
• Flexible usage: Funds can be used for education, weddings, medical needs, or business.
• Quick approval: Digital pledge process makes disbursal faster.

When to take a loan against mutual funds vs when to redeem?

Choose LAMF when:

• You need urgent funds but want to retain your investments.
• You expect the fund’s NAV to grow in the future.
• You want to avoid tax on premature redemption.

Choose redemption when:

• The fund is underperforming and does not align with your goals.
• You do not wish to take on repayment obligations.
• You are restructuring your portfolio.

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While LAMF is convenient, it comes with certain risks you must be aware of:

• Margin calls: If the value of your mutual funds falls, the lender may ask you to top up the margin or repay part of the loan.
• NAV fall: A sharp drop in NAV can reduce your loan eligibility and risk foreclosure.
• Default consequences: In case of non-repayment, pledged units may be sold by the lender.
• Operational risks: Always track repayment schedules and maintain an adequate balance to avoid penalties.

Alternatives: LAMF vs unsecured loan vs overdraft vs systematic withdrawal plan (SWP)

Below is a comparison between LAMF, unsecured loan, overdraft, and systematic withdrawal plan.

Eligibility documents and quick checklist for loan against mutual funds

To apply for a loan against mutual funds, you need to fulfil basic eligibility and provide certain documents.

Checklist:

• Eligibility: You must be an Indian resident with valid KYC documents.
• Age: Typically 18–90 years (varies by lender).
• Mutual fund type: Both equity and debt funds can be pledged.
• Documents required:
  • PAN: Any one of the Officially Valid Documents: Aadhaar, Driving License, Voter ID, Passport, NREGA Job Card, Letter issued by National Population Register
  • Mutual fund account statement
  • Bank account details

Conclusion

Deciding between loan against mutual funds vs redemption depends on your immediate financial need and long-term investment strategy. Redemption offers simplicity but may eat into your future wealth, while LAMF ensures liquidity without derailing your goals. For short-term needs, borrowing against mutual funds is often a smarter and more cost-effective choice.

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