Home Loans & the 80-20 rule

 RBI increased the Interest rates this week, as a result, the EMIs on loans are going to go up. In such a situation, People who will be most affected are the ones who have long term loans on high principal amount aka the Home loaners. In this week's blog, we decided to share a simple hack to help the home loaners gain back the amount paid to the banker irrespective of the Volatility in Interest rates. Lets get into the Assumptions and Math of the Hack. 

Assumptions -     

The Average size of home loan now a days is 50 lacs (60 lacs being the cost of 2BHK). The Interest rate is about 7.4% and Buyers generally opt for 15 years pay back period since they believe 10 years is too heavy on the budget & 20 years is too long. So the EMI will work out to be INR 46,000 

Hack - 

Our hack (suggestion) is that the day you start paying your Home loan, you start saving 20% of the EMI amount, in this case, it will be INR9000. Now a lot of you would think that "46K itself we are not able to pay, from where to bring the extra INR 9k", So

The Real Hack - 

OK, Here's what we think will really work!  

Increase the Loan Tenure to 20 Years. Sure, your minds would go like - Really!?! Yes, Really. This will help you save the 20% that we can invest for the loan tenure period ie., 20 years. (46K - 39K = 8K which is 20% of 40K, our new EMI). 

Now Invest this 8K in an Interest yielding instrument. Investors have 2 options, one is Debt Market and another Equity. analyzed as below - 

You keep Investing this Savings as it suits you and at the end of the Tenure, this is what you will have depending on where you chose to invest your money in. 

You will have either 80% of the House value or 75% of what you paid to banker. The most important thing to note here is this will be in almost cash form. (meaning can be easily converted to cash)   

Isn't prepaying the Home Loan a better Idea?  Now lets try and look at the question from statistically point of view, We have not seen anybody foreclosing their Home loans in 5 year or lesser tenure and neither they stretch it until end of tenure. We will assume that Loaners repay the loan in 10 Years (mid point). It means they need to make additional payment of 13,000 every month. Now, Mind you, At the beginning of this blog, we asked ourselves, this question 

-  "46K itself we are not able to pay, from where to bring the extra 9K"

So for most of us, Prepaying is not feasible even it is perceived to be a better idea. 

But Beyond it, If somebody is still able to repay the Loan in 10 years even then he would have paid 60% of the Expected Interest payable to the banker. On top of that, at the end of 10th year, He will have no other saving other than his house. (Note that he is using all his additional savings to prepay the loan). When you are in late thirties or early forties having only an old house and nothing else as savings is not a desirable place for sure.

Dear Home Loaners, this is why we recommend that you use 80-20 hack when you decide to get a home loan or if you already have one. Just to make our recommendation stronger, we are listing down the benefits of saving 20 % of EMI amount and not prepaying the loan. 

1. The longer the loan continues, the longer you get the tax benefits. We know people who buy 2nd house because they want to use the tax benefit. Not the right motivation.
2. Saving up a portion of EMI in debt/equity helps create a corpus which in short term can be used for Emergency purposes
3. Saving up a portion of EMI in debt/equity helps create a corpus which in long term can be used for Retirement.
4. Finally the most important things, locking up all your saving in home with no liquidity reduces your options in life but having some savings else act not only as shock absorbers in case of financial mishap but help you make better choices.

We strongly recommend that before you buy a home on loan, you give it a deep thought and If possible talk to financial advisor, make a clear plan, then act. Else it is going to be like owning an elephant in the current inflationary scenario.

For financial planning and investment-related queries, write to us at dropletadvisory@gmail.com or call us at 9962399924 / 9551373455. Visit our website - www.dropletwealth.com