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Dealing Debt Fund Units vs Taking a Particular Loan

Dealing Debt Fund Units vs Taking a Particular Loan

You need Rs 5 lacs to fund an important event in your family. You have 2 options.

  1. vend your debt finances( you had erected up an exigency fund using debt finances for similar situations only)
  2. Take a particular loan

Dealing with your debt finances seems a superior decision over taking a particular loan. Why?

Because the post-tax returns from your debt finances are doubtful to beat the cost of a particular loan. thus, you’re better off dealing with your debt MF investments than taking a particular loan. still, there’s disunion when you vend debt collective finances. That disunion is in the form of levies. Can this affect your choice? Let’s see how to suppose about this problem.

How Are Debt collective finances tested?

still, the performing capital earnings shall be considered short-term capital earnings( STCG), If you sell your debt fund units before completion of 3 times. STCG on debt finances is tested at your borderline duty rate( duty type).
still, the performing earnings shall be considered long-term capital earnings and will be tested at 20 after indexation, If you vend after completion of 3 times.
still, you would find duty governance is kind to long-term capital earnings, If you’re in 30 or advanced income duty classes. Hence, you would want your capital earnings to be tested as long-term earnings rather than as short-term earnings.

How Does Taxation Affect Your Choice?

still, you’ll have to pay some levies too, If you vend your debt finances to fund your demand. And that needs to be considered. Let’s say you need Rs 5 lacs for your demand. You had invested Rs 5 lacs 2 times. Now, the value has grown at 6 sire to Rs5.62 lacs.

As you can see, to fund your demand, you must vend further than Rs 5 lacs. That redundant quantum is because of levies and that’s a fresh cost. The amount of levies will depend on your net returns, borderline duty rate, and the holding period. In the table over, I’ve considered a borderline duty rate of 30. The lower the duty rate, the less you pay in levies( and redeeming debt fund units get a more seductive option).
I concentrate only on the short-term earnings( holding period of lower than 3 times) because if the units are long-term, the duty governance becomes relatively benign( you pay 20 after indexation on Long term capital earnings). still, dealing with long-term units will probably be a better option than taking a particular loan, If the earnings are long-term.
Now, a discrepancy with the net quantities you’ll have to pay if you were to go for a particular loan.

You can see that the quantities aren’t too different, especially for shorter loan durations. You can calculate net scores for your demand. And choose where you have to pay lower duty.

Point to Note

The debt fund units will ultimately be vented. And similar trade will affect capital earnings duty liability. You might ask if the levies ultimately have to be paid, why not pay them now? Why bear the gratuitous cost of a particular loan when levies can’t be avoided? Valid point. And that’s why dealing long-term units in debt finances is a better choice than taking a particular loan because you don’t save anything by NOT dealing long-term debt fund units. Whenever you vend, you’ll have to pay LTCG duty.

Why not pay it now? The only saving is in the form of the time value of the plutocrat. But that’s nowhere close to the cost of a particular loan.
What about short-term units? By NOT dealing with short-term units, you’re trying to convert short-term units to long-term units. And pay lower duty.
While the units are short-term, you pay 30-duty ( borderline rate) on capital gains. However, your borderline duty rate can go as high as 42, If you belong to the high-income group.7 due to cess and cargo.
When the units come long-term, you pay 20 after indexation on capital earnings. The net duty rate could be 15, 10, 5, or indeed negative. Depends on the situation of the Cost- of- affectation- indicator( CII) blazoned by the Government of India.
still, your analysis must support that the duty savings ( from letting short-term units come long-term units) are lesser than the interest cost of a particular loan If you conclude for a particular loan in place of dealing with debt MF units.
For a complete analysis, I should have considered the net impact of converting short-term units to long-term units( and not just levies on short-term units). I leave it to you to make this analysis.

particular Loans Have Friction Too

Personal loans also have disunion. piecemeal from the interest cost, there will be a processing figure that increases the effective cost of borrowing and your net obligation.
also, there’s a prepayment penalty that reduces your inflexibility. In the absence of any prepayment penalty, you would pay off the high-cost loan as soon as you have the cash available.

Your Cashflow Position

A particular loan would bear prepayment and your cashflows must support similar repayment. However, don’t complicate matters, If you know outspoken that your cashflows can’t support loan prepayment. Just vend the debt fund investments.
Why? Because ultimately you’ll have to. To pay particular loan EMIs. Why complicate matters?
The choice between the particular loan and the trade of debt fund units must be considered only when your cashflows are strong enough to support loan disbursements.
Note that in all the exemplifications bandied in this post, there may be corner cases where the action I suggest may not be the most optimal mathematically. Not possible to cover all possible scripts. Hence, for your demand, do the calculation and use your judgment.

An Overdraft Installation against Your Debt Finances May Be the Stylish Result

still, a secured overdraft installation could be a good result, If your loan demand is short-term. rather than dealing with your debt finances, you take an overdraft installation against those finances. Since there’s no trade, there’s no capital earnings duty liability. either, an overdraft is a revolving installation. You can compensate whenever you want. No inflexibility issues as in the case of a particular loan. also, a secured installation against debt finances( or bank fixed deposit) may reduce the overdraft interest rate too. The only thing to watch out for is the processing figure, which can increase the overall cost of the sale.

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