I was going through the responses to previous articles on housing loans, particularly those on whether you should go for a fixed or floating loan. And I realised there was one common element in all the questions -- the readers were looking at housing loans in a stand-alone manner. That's ironic!
Any family/ individual paying back a housing loan, or planning to go for one, cannot afford to look at housing loans in isolation.
However, as this is a very big component of their personal finance, they tend to focus only on this aspect. You need to be remember that the housing loan is only a part of your overall finances; though it is a relatively larger part, it is still a part.
Next, you must know what your objective is; it cannot and should not be to only repay the loan (though this is the reason in most cases, it is not advisable). If your only objective is to repay your loan then, by the time you have repaid it, you will be older by 20 years without having any sizeable corpus for your retirement.
Plus, since you would be focusing only on the repayment of the loan during your earning life, there is a good chance you might have taken many other relatively smaller loans at various points to meet certain additional requirements. It might be for a laptop, or for your child's education or for that matter her/ his marriage.
Now, try to look at what you are doing from the other angle.
You have got time today, but you are so overwhelmed by the housing loan that you are not focusing on anything else. Time progresses, you pay EMIs regularly, but do not make sufficient investments.
The excuse you will give is you don't have any money left (at the same time, you will not be ready to forego the Saturday night parties or the branded clothes you love to wear). Then come other responsibilities like child birth and education (my child will go to the best possible school), you want to buy a car (how long can I travel by public transport?), your child needs to go for tuitions (it's a taboo in India if you don't send your child for tuitions for Std X and XII), then comes her/ his higher education (you may even look at education abroad).
The list can be as long as you want. Every time you need money, you go to the bank, take a loan, then keep paying the EMI for years!
That means you are ultimately doing the same thing, breaking a huge sum into small parts. This makes me wonder... if you don't have money to invest, where are you getting the money to pay off your EMIs? Arre bhai, this is nothing but forced discipline. And if you are forced to be disciplined, then you have to pay a price, which is the interest you pay on the loans you take.
If you maintain this discipline without being forced, you are rewarded with the interest your money earns.
Let's say you want to buy a car, but are currently not doing so because you have a huge housing loan. So you plan to defer it by another five years. Look at the two scenarios below and decide in which scenario you would like to see yourself in.
The date today is April 23, 2007.
The date you want to buy a car is April 23, 2012.
Cost of car after five years: Rs 10 lakhs approximately
Your mantra: Invest today, buy later
|
Annual rate of return |
8 per cent |
12 per cent |
14 per cent |
16 per cent |
|
Monthly SIP |
Rs 13,520 |
Rs 12,125 |
Rs 11,470 |
Rs 10,841 |
|
Investment |
Rs 811,200 |
Rs 727,500 |
Rs 688,200 |
Rs 650,460 |
|
Interest earned |
Rs 188,830 |
Rs 272,647 |
Rs 311,992 |
Rs 349,615 |
As can be seen from this table, if you invest Rs 13,520 every month for next five years in an instrument which gives an annual return of 8 per cent, then, after five years, you will have the money you need to buy that car. The best part would be, you would have invested only Rs 8.11 lakhs; the remaining amount comes from the interest earned.
Also, you would not have the liability of paying the EMI every month for the next five years. If you are among the aggressive types, you can go for riskier investment avenues. In this case, you would have to invest a lesser amount that may fetch higher returns as shown in the illustration above.
Buy first -- Service the loan later
|
EMI |
Interest paid |
Principal |
|
Rs 22,244 |
Rs 334,667* |
Rs 10,00,000 |
*Assuming rate of interest at 12 per cent for a 5 year new car loan of Rs 10 lakhs
This table shows what the situation would be in case you choose to buy that car by taking a loan. For a five year loan, you would have to pay an EMI of Rs 22,244 for five years. While doing so, you would have effectively paid an interest of Rs 334,667 over the 5-year period.
As can be seen in the above two scenarios, if you invest close to Rs 11,000 per month today for the next five years at the rate of 16 per cent, you will approximately earn the same interest you will pay if you take a five year loan. The choice is yours -- do you want to earn or do you want to pay?
There can be deviations in the above calculations, as interest on car loans is calculated on a daily reducing balance. But since we are assuming the SIP is on a monthly basis, and the interest earned is also on a monthly basis, we have taken loans on a monthly reducing basis.
Looking at the above example, you may wonder which investment will give a guaranteed 16 per cent return consistently for a five year period.
However, the point here is not the accuracy of numbers or which investment will deliver such returns; what is more important is the concept. If the EMI and interest is calculated on a daily reducing basis, the fact still remains that you end up paying interest. Even if you invest even at 8 per cent, the fact remains that you earn interest!
Here are the points we are trying to emphasise:
~ A housing loan is an integral part of your overall finances.
~ It is a significant part of your overall finances.
~ Yet, a housing loan is only a part of your overall finances.
~ There are other elements in your personal finance as well.
~ Wasted time never returns.
~ Forced discipline costs you money.
~ Self-discipline earns for you rewards.
~ Earning interest is far better than paying interest.
~ If you plan well, you need not sacrifice your Saturday night parties and branded clothes.
The author runs a Mumbai-based finance advisory Money Bee Investments.
Disclaimer
This article is for information purposes only. Please consult your financial advisor before taking decision based upon this article. Money Bee Investments or any person/s related to it, directly or indirectly will not be liable under any circumstances, for losses incurred due to decisions taken on the basis of this article.
Numbers arrived at are based upon some assumptions, these may vary for each individual, depending upon assumptions made.