Home Loan Liability Or Tool

By Nikhil Shah

Buying own house is one of the biggest achievement in any individual’s life. Feeling of this achievement is truly great in all aspects. It is cherry on cake when one’s buying this house without any loan.
However buying home with loan can be intelligent decision too. Does it sound SHOCKING! It’s true. Home loan is a good liability and how. Just like using electricity. Cautious use has lots of benefits and can give shock as well if not used cautiously.

Lets Understand this HOW:

We’ll start with the cons first. While home loan might be a necessity, that doesn’t mean they’re without their disadvantages.

Home loan Cons.

  • They’re a big commitment: When you’re approved for a home loan, you’re taking on a decades-long commitment. Say 20 to 30 years.
  • They carry some risk:  Unforeseen life events like illness, unemployment or divorce and such circumstances can arise that could make it difficult for you to keep up with your home loan repayments.

Home loan Pros.

  • They make homeownership possible: This is the major advantage of a home loan.
  • The return on investment often outweighs the cost:  In most cases, borrowers who hold onto their homes for a significant period of time will see the appreciation in value outweigh the cost of their home loan.
  • They’re a form of forced savings:  When you make regular  emi on your home loan, you’re building up what’s known as saving.
  • Cheapest form Credit:  The best reason to opt for a home loan is that it’s comparatively the cheapest form of credit available. Other options are costly like credit card loans, car loans, personal loans etc.
  • Tax benefits:  The only credit which gives benefit on tax  big way. As per last budget tax benefits on home loan are Rs. 1.5 lacs u/s 80 C to Rs. 2.0 lacs. u/s 24 and recently started again Rs. 50,000/-  u/s 80 EE , (I will cover tax benefits of house loan in separate blog in detail).
  • Pre payments: This is another feature which is not having any charges in the most of the home loan products available in market.

In India, any type of Debt mostly considered not good and if anyone having it, that person tries to repay it as early as possible.

In most of the cases one who has home loan tries to finish the home loan by doing higher pre payments by ignoring saving for other important goals of life.
Here one needs to think on below questions before  doing pre-payment for his home loan.

  • Does one should do prepayment if he has extra surplus in a month ?
  • Does yearly bonus should be used for prepayment of home loan ?
  • One should increase home loan for renovation of house or should pay it from other savings ?
  • Doing pre-payment to finish home loan early should not make suffer other important goals of life. ?

Illustration:

Mr. Swami senior IT professional wanted to increase his number of houses as much as possible due to peer pressure to have higher number of houses. ( Just like any sportsperson try to break records of other players.)

Currently Mr. Swami has got a deal of buying house as below

House Cost: 75 lakhs

He can get Home loan on this House property as below detail:

Loan Term:     20 Years
Loan Rate:     8.5% Annual.
Maintenance: 50,000/= annual exp.( house property tax, monthly building maintenance and house insurance premium.)

House Property Value over 20 Years period.

During 20 Years Period assuming House property will grow at 10% rate (as per past avg. long term performance of real estate) annual CAGR rate. So 75 Lakhs House value will become 5 Cr approx.

Net Value in hand after selling of house would be 5 Cr. approx. (Tax is not included currently)

Now as Mr. Swami has decent pay package. He can afford any one of below 2 options.

Option 1: Doing monthly Pre- Payment. And Starting saving later for future goals.

or

Options 2: Doing No monthly Pre-payment. And Starting saving immediately.

Let us see this both options in practical.

Option 1:

In this option by doing higher monthly pre-payment with EMI he will try to finish home loan early. And start saving for his future goals later as below.

Home Loan: 60 lakhs. for 20 years period.
Down Payment: 15 lakhs.(20% as down-payment.)
Pre-Payment: 20,000/= (monthly payment extra over EMI)

Monthly EMI for this Home loan will be :  52,069 /=

After finishing home loan in 12 years he will start saving monthly for his future goals the amt which he was doing as pre- payment for next 8 years in fixed income product (Fixed Deposit / Bond / Debt Mutual Fund).

Monthly Investment : 70,000/= (Pre-payment) for 8 years period.
Rate of Return: 8.5% CAGR (Considering investing at Home loan rate only safe & fix in fixed income product)
Investment Period:8 Years.

Total amt saved for future goals after 20 years : 95 lakhs approx.

Below is home loan calculation calendar year for ref.

Image 1

Options 2:

In this option by doing regular EMI payments he will try to finish home loan as per provided home loan period. And start saving for his future goals immediately as below.

Home Loan: 60 lakhs. for 20 years period.
Down Payment: 15 lakhs.(20% as down-payment.)
Pre-Payment: NA

Monthly EMI for this Home loan will be :  52,069 /=

He will finish his home loan in 20 years. However he will start saving monthly for his future goals with immediate basis the amt which he was doing as pre- payment for 20 years in fixed income product (Fixed Deposit / Bond / Debt Mutual Fund).

Monthly Investment : 20,000/= (Pre-payment) for 20 years period.
Rate of Return: 8.5% CAGR (Considering investing at Home loan rate only safe & fix in fixed income product)
Investment Period: 20 Years.

Total amt saved for future goals after 20 years : 1.25 Cr. approx.

Below is home loan calculation calendar year for ref.

image 2

Final results after 20 years period are as below:

Option 1:  5 Cr. (House price) + 95 lakhs. (Investment value) =   5.95 Cr. approx.

Option 2:  5 Cr. (House price) + 1.25 Cr. (Investment value) =  6.25 Cr. approx.

Note: For easy understanding figures has been rounded off.

By just starting investment early how Mr. Swami can save almost 30 Lakhs extra through Option – 2.

Note: In both options investment is done at home loan rate only i.e 8.5% Annual rate (CAGR), which can be delivered by fixed income product. (Fixed Deposit / Bond / Debt Mutual Fund)

However historically after seeing so much of crisis, wars, scams and events in markets. It has been observed over such long period of investment in Equity as an asset class has delivered 15% Annual rate (CAGR).

And it has capacity to outperform other asset class in future also over such long period.

How Mr. Swami could have increased is net returns by doing monthly 20,000/= SIP in any diversified equity mutual fund over 20 years period at different Annual rate (CAGR).

Monthly SIP
20000
Investment period in years
20
Annual Rate (CAGR)
10% 11% 12% 13% 14%
1.55 Cr.  1.75 Cr.  2 Cr. 2.30 Cr. 2.65 Cr.
House Value after 20 years
5 Cr. 5 Cr. 5 Cr. 5 Cr. 5 Cr.
Net Value in Hand of Mr. Swami
6.55 Cr. 6.75 Cr. 7 Cr. 7.30 Cr. 7.65 Cr.

Now what should Mr. Swami say “Home Loan is Liability or Tool.”