Need extra money? Should you borrow or redeem investments? Here's how to decide

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A sudden medical emergency.
An unforeseen major repair for your house.
An impromptu vacation that you're eager to take.
Or an unexpected calamity that damages your car.

All of these situations have one thing in common - they all require you to spend extra money that you hadn't originally planned for. And when you have to take care of such unplanned expenses, how do you arrange for the extra funds needed? Long story short, you have two options.

  • You could borrow money by taking a loan

  • You could liquidate your investments

Which of these two options should you go with, though? The answer is not a simple choice. It depends on a number of factors like your financial status, your repayment capacity and your existing debts and investments.

To give you more clarity on how to decide between the two options, let's take a closer look at the advantages of each course of action.

The upsides of borrowing money

Borrowing money may seem like a financial burden. However, with the right financial plan, you can easily accommodate a loan in your finances. And what's more, you can also enjoy some of the distinct advantages that come with availing a loan as opposed to redeeming your investments. Here are some such upsides of availing a loan.

  • Your investments remain intact

    The biggest advantage of taking a loan is that your investments remain unaffected. This way, you can continue to build wealth on the one hand, while borrowing money for your immediate needs on the other.

  • You build credit history

    Taking a loan helps you build credit history. And if you repay your loans on time, your credit score improves. And a good credit score is always beneficials, since it makes it easier for you to borrow money later, if you need to.

  • You can access funds instantly

    It is common for loans to be disbursed within a very short time these days. Once your application is approved, you can expect the funds to be credited to your account almost instantly.

When is it a good idea to take a loan?

So, how do you know if a loan is the right option for you? Here are some situations when a loan may benefit you more than investment redemption.

  • If you do not have any investments
  • If you have a reliable source of income that can help you repay your loan
  • If you have a good credit score and find it easy to avail loans at affordable interest rates
  • If you are not already burdened by debt

The upsides of redeeming your investments

If you are considering redeeming your investments instead, there are some advantages to this course of action too. Primarily, it can help you avoid getting into debt. In addition to that, there are other benefits of liquidating your investments

  • You can avoid taking on additional debt

    For most people, taking on more debt may not be a smart financial move. And by redeeming your investments instead, you can avoid taking on additional debt. This may be financially beneficial for you in the long run.

  • You need not worry about additional expenses

    Taking on a new loan comes with the additional burden of monthly EMIs. Depending on the rate of interest and the tenure of the loan taken, you may have to set aside a considerable portion of your monthly budget to repay the loan. This will not be the case when you redeem your investments instead.

  • Partial liquidation can help keep a part of your investments intact

    If you choose to redeem your investments instead of availing a loan, you can even opt for partial liquidation, so some of your investments continue to remain intact.

    For instance, say you have invested Rs. 10 lakhs totally in your PPF account, and you have held your account for at least 5 years. Now, if you need around Rs. 2 lakhs for an emergency expense, you can withdraw just the amount needed from your PPF account, leaving the rest of the investment intact.

When is it a good idea to liquidate your investments?

You've seen the advantages of liquidating your investments to meet emergency cash requirements. Now, let's take a look at some scenarios where liquidating your investments may be the right choice for you.

  • If you already have a considerable amount of debt
  • If you do not want to taken on the added stress of EMI repayments
  • If you have enough investments to rely on for your major life goals

The best of both worlds: A loan against your investments

If you are still unable to decide which course of action to take, you may find the option of taking a loan against your investment ideal. Today, there are many assets in the Indian market that act as a reliable collateral for borrowing money. Here are some such options that you can consider.

  • A loan from your PPF account
  • A loan against your car
  • A loan against gold
  • A loan against property

Aside from the options given above, you can even avail a loan against your life insurance policy, if you have one. This is a convenient way to take care of any emergency expenses without tapping into your investments.

The bottomline: A quick cost-benefit analysis

Ultimately, to make the decision between availing a loan and redeeming some of your investments, you can rely on a quick cost-benefit analysis. To do this, simply compare the cost of availing a loan with the benefit you'll forego by liquidating your investments. And choose the option that is less expensive.

For example, say you need some extra funds to pay for an essential premium purchase. You have the following two options before you.

  • Avail a loan that comes with an interest rate of 12% per annum
  • Liquidate your fixed deposit that gives you interest at 5.5% per annum

In the above case, your choice is quite clear. By redeeming your FD, you lose out on 5.5% interest per annum. But by availing a loan, you take on a new interest expense at 12% per annum. So, redeeming your FD may be the better option here.

However, if your investments offer you returns greater than 12%, it may be better to avail a loan instead.

Conclusion

The choice between borrowing money and redeeming your investments is not always a clear-cut decision. There are several things that you need to weigh before choosing one of these options. So, take your time and make a smart financial decision. And if you have trouble doing this, you can always approach a financial advisor for their expert guidance.

Read next: HAVE YOU PLANNED FOR EMERGENCIES? IF NOT, TAKE THESE STEPS RIGHT NOW

Planning ahead can ensure that you are sufficiently prepared to take care of any financial emergencies. We have a blog that outlines some steps you can take to plan for uncertainties.

Read it here

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