achin, 27, is well on his way up the corporate ladder. He got married recently.
Buying a home is now at the top of his list of big-ticket expenses. He wants to make it a priority because he feels that, once he has children, his capacity to save will diminish.
On the flip side, his job requires him to travel quite a bit; besides, he is not sure in which city he will be based. So he wants to buy a home five years down the line.
What he wants to do now is start saving specifically for this goal.
Srikanth Bhagavat, managing director, Hexagon Capital Advisors Pvt. Ltd was asked to help him decide on his investments. After a lengthy discussion with Sachin, here is what Bhagavat has to say. If you would like to write to Mr Bhagavat, drop us a line.
Step 1: Decide how expensive a home you can afford
Home buyers generally go by two parameters when it comes to deciding how much they can afford to spend on an apartment.
The first is the amount of money they can pay towards the home loan every single month. This is referred to as the Equated Monthly Installment.
The other is the down payment they will have to make. The home loan company will not pay the full amount but expect the buyer to pay part of it upfront.
On an average, home loan companies will pay around 80% to 85% of the cost of the home. The remaining will have to be borne by the buyer. The home loan company sanctions the loan only after he does so.
To understand these concepts in detail, read 10 home loan terms you must know.
Sachin and his wife were clear they did not want to commit to a very large EMI. If the EMI consumed a large proportion of his earnings, it would not leave much room for increased expenses which would become inevitable once they had children.
They were also particular that spending too much on a home would result in a large part of their net worth being locked. Besides, larger homes result in higher maintenance charges.
Always remember that capital appreciation on your home is only notional. You are not going to be selling it to make a profit.
Based on these critera, Sachin decided he wanted to limit his home loan to Rs 25,00,000.
The approximate EMI for this loan would be Rs 24,000 for 20 years. This left Sachin with a margin of safety that would allow for both emergencies and good investment opportunities that could present themselves.
Step 2: Decide when you want to buy your homeSachin was clear he wanted to buy a home five years down the line.
During this time, property prices would go up.
Due to inflation, the cost of that apartment would increase to Rs 33,50,000.
The loan will take care of 80% of the cost (Rs 26,85,000) and the down payment to be made by them would have to be (Rs 6,65,000).
Hence, Sachin's target amount for saving over 5 years is Rs 6,65,000. Step 3: Decide on how much has to be savedSince Sachin is still quite young and his horizon is five years, his risk appetite can be assumed to be high. This means he can take a chance by investing in equity (shares) and equity mutual funds. These are mutual funds that invest in the shares of various companies in different sectors.
Sachin, however, is not comfortable with this option; the end use of the money is a home and neither Sachin nor his wife want to take this kind of a risk with their savings.
The couple were clear they would be more comfortable with a balanced portfolio. This would mean half of their savings would go into shares or equity mutual funds and the rest into fixed return instruments (such as fixed deposits and bonds).
Assuming that equities as a class will earn a return of 15% per annum and bonds 6% per annum, the balanced portfolio could give an overall return of around 10.5% per annum.
Sachin also agrees to the assumption that his capacity to save will increase by 10% every year due to increments.
Currently, Sachin earns around Rs 3,60,000 per annum. By the time he has to start paying his EMI, his pay would be more than Rs 5,65,000 per annum.
Hence, Sachin's monthly savings will have to be:
Year 1: Rs 7,102
Year 2: Rs 7,812
Year 3: Rs 8,593
Year 4: Rs 9,453
Year 5: Rs 10,398
Step 4: Decide where to invest the money
Based on the long-term risk-adjusted returns of various mutual funds, here are the ones that Sachin decided to invest in.
1. Fifty percent of his savings would go into equity funds.
a. HDFC Equity Fund
b. Franklin India Prima Plus Fund
2. The balance would be invested in bond funds (funds that invest in fixed return instruments).
a. Prudential ICICI Short Term Plan
Since he has to save over time, a Systematic Investment Plan is the ideal way to invest.
An SIP is an investment option offered by mutual funds to help you save regularly. Every month or once in three months, you will have to deposit a cheque of a pre-fixed amount with the mutual fund. Mutual fund units are accordingly allocated to you.
To understand SIPs in more detail, read How to invest in a mutual fund.
Step 5: Look at the tax angle
The income tax advantages to borrowing a home loan are attractive.
Under Section 80C of the Income Tax Act, principal repayment for up to Rs 1,00,000 is deductible from your income when it comes to calculating tax. To see what is included under Section 80 and how the deductions are calculated, read All about Section 80C.
Further, under Section 24, up to Rs 1,50,000 paid as interest can also be deducted from your income.
5 questions home loan seekers ask will tell you all about the tax benefits on a home loan in detail.
Sachin, of course, will only get this benefit when he actually takes and starts repaying the home loan.
In the meanwhile, he can even invest in Equity Linked Saving Schemes. ELSS are diversified equity funds that come with a tax benefit.
Sachin also has the option of saving in an ELSS for the first two years since it has a three-year lock-in period. An SIP works here too. The recommended ELSS is HDFC Long Term Advantage.
Start now!
Even if you are in your 20s and do not have the money or the earnings to justify a home loan, start saving for it now.
You can open a recurring deposit with the post office or bank. Or, since you are young, a better option would be an SIP with a mutual fund.
Regularly put aside money for a home. When you are ready to take the plunge (emotionally, physically and financially) and buy a home, you can utilise these savings.
Buying a home is a tremendous financial responsibility. The sooner you move towards it, the better for you.
Illustration: Dominic Xavier
Disclaimer: The information provided is specific to a particular case. It cannot be generally applied to every couple in the same group.
