Need Funds? Selling an Asset vs Taking a Loan

You need money but you do not have cash readily available. What would you do? Let’s rule out borrowing from friends & family OR taking salary advance as options. Beyond these, you have two options.

  1. Sell some of your investments / Withdraw money from your investments OR
  2. Take a loan

While selling investments is easy to understand, loan options can get quite exotic. You have plain vanilla personal loans, gold loan, medical loan, top-up home loan, loan against fixed deposit, shares or mutual funds, loan against property, salary loan, peer-to-peer loans (P2P loans) and many more. Moreover, loans are easily available these days if you have the right credit profile.

I frequently come across articles where the authors advocate a particular kind of loan over the sale of an asset (or withdrawal from an asset). In an earlier post, I had compared medical loans and health insurance. I got the idea about the post after reading an article which had an insipid suggestion that a medical loan is a better option than health insurance to take care of your hospital bills. When your tool is a hammer, every problem looks like nail. A lender can only offer loans. Therefore, for any need of funds, they show that a loan is a better option. Such articles are motivated and sales-oriented and should be seen in such light.

As someone who finds himself in such a situation, what would you do? Would you sell one or more of your assets or would you apply for a loan? Let’s look at the pros and cons.

Why Sale or Withdrawal from an Asset Is Likely a Better Option?

You must pay interest on the loan. For some of the loan variants, the rate of interest can be quite high. Had you sold the asset / investment, you wouldn’t have to incur the interest cost. Moreover, you must also compare the returns from asset you didn’t sell with the loan interest rate. It is foolish to continue with your bank fixed deposit at 8% and take a personal loan at 10 to 12% p.a.

Even for the assets that can yield potentially more than cost of your loan, you must consider that the returns from high yielding assets are not guaranteed but the loan must be repaid. Let’s say you have Rs 20 lacs equity portfolio. Your equity investments may offer you more than 10% p.a. over the long term. However, there is no guarantee of good returns and no guarantee that you will get good returns year after year. For all you know, you may be down 10% in the next 12 months while you continued to pay 10% on your loan. Taking loan while holding the investment wouldn’t look like such a good decision, would it?

The loan must be repaid. If you cannot repay, there will be penalties and many other hassles. If you have taken a secured loan, you can lose control of the asset if you can’t repay the loan for any reason. This is important especially when your repayment ability is suspect. You took the loan because you didn’t want to sell. However, if you can’t repay the loan, the bank will eventually sell it.

In my opinion, sale of an asset (withdrawal) is likely to be a better choice in most cases. However, there could be some situations where you may be forced to consider availing a loan instead.

When the Sale of Asset Can Be a Tricky Choice

  • There is a heavy transaction cost. For instance, real estate transactions will have heavy transaction cost.
  • There are tax implications. Sale of an asset typically results in capital gains and you must pay tax on those gains.
  • There can be penalty on exiting the investment before maturity. For instance, in case of bank fixed deposits, there can be a small penalty for premature closure. Moreover, you may be offered an interest rate for the shorter duration (period for which you maintained the fixed deposit and not the original tenure).
  • Fund requirement is much smaller than the value of the asset. You may not want to sell a Rs. 2 crore property to fund a Rs 10 lakh requirement. The operational hassles, transaction and tax cost may be too much.
  • Similarly, you may not want to break a 2 crore Bank Fixed deposit to fund a Rs. 20 lacs requirement. This is especially if the interest rates have gone down since you made the first FD. I have discussed this aspect in detail in another post.
  • Re-investing the money in the same instrument is difficult. Let’s consider the example of Public Provident Fund (PPF). You can make partial withdrawals from the 7th year. Once the account completes the initial maturity, the withdrawals are much more flexible. So, you can take out money from PPF easily. However, you cannot put more than Rs 1.5 lacs in a financial year. Therefore, if you take out a big chunk from PPF, you may not be able to replenish it later even if you have the money.
  • There is a strong emotional connect with the asset. Examples could be your ancestral property or gold.
  • You believe that the asset is worth much more, but you think you wouldn’t be able to get to right price under current market conditions. You may be right but you may also be living under an illusion. For all you know, your asset/property may not be worth as much.

Do note the presence of aforementioned factors does not necessarily rule out the sale of the asset or withdrawal from it. It merely requires you to dig deeper and do a holistic cost benefit analysis. Be rational.

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