An RM of one of the largest mutual fund houses came to share an investment proposal with me.
Somehow they came to know that I am going for a home loan for a 20 year period. The RM said “Why don’t you go for a 30 year loan?”
Given the fact that I deal with such matters as a part of my work, I pushed back.
“Are you out of your mind? A 30 year loan means more interest to be paid, why should I do that?”
“Sir, let me explain.” The RM was persistent. “I want to share a plan by which you can not only pay your EMIs but repay the home loan in a smarter way.”
I was all ears. Here is what the RM proposed.
Let’s assume you take a home loan of Rs. 45 lakh at the rate of 9.6%. The EMI payable for the 20 year period is Rs. 42,240 per month. However, if you take the loan for 30 years, you EMI will reduce to Rs. 38,167.
The difference in EMI is Rs. 4,073. I suggest that with the difference amount of the EMI you start an SIP in an equity mutual fund scheme.
See the table below with 2 scenarios of a 20 year loan and a 30 year loan.
Now, let’s fast forward 17 years and look at the position then.
In the 20 year loan scenario, you only pay your EMIs.
In the 30 year loan scenario, you pay your EMI as well as do your SIP. Your overall outflow remains the same over the 17 years, that is, Rs. 86.17 lakhs.
However, in the first scenario, you have a loan outstanding of Rs. 13.15 lakhs and in the second one, it is Rs. 33.93 lakhs.
“See, that’s what I was trying to tell you. Huge difference in loan repayment!” I felt I won.
The RM was quick to come back. “Sir, please. Just another minute.”
The SIP of Rs. 4073 per month that you have been doing is valued at Rs. 37.82 lakhs at the end of 17 years. You simply withdraw that amount equal to your loan and prepay the entire loan outstanding of Rs. 33.93 lakhs.
You get not just loan free but you also have a net investment surplus of Rs. 3.88 lakhs (Rs. 37.82 lakhs minus Rs. 33.93 lakhs). Not to mention the fact that you don’t have to pay any more EMIs and you can use that amount to make more investments.
I couldn’t believe what I saw. It looks exciting. I am holding my horses though. My mind is still trying to find holes in this message.
While I find them, can you tell me if this is a proposal worth going for? “What can go wrong?”
Update: Here’s the link to my analysis and conclusion.
Please do help me. Post your comments below with your analysis of the investment proposal.
We are assuming 15% return over 17 years, thats the catch. Take a reasonable 8-10% and then see the calculation 🙂
I see at least 3 bad assumptions with the proposition:
1. It is assumed that everyone will be eligible for a 30 year loan period.
2. The SIP returns at 15% annualized look too much.
3. The home loan rate of interest at 9.60% looks very less, especially when compared to expected SIP return rate.
As per my calculation :
Principal O/S for a 20-year loan is INR 13,16,726.
Principal O/S for a 30-year loan is INR 33,94,459.
Things that need to be considered:
1. Home loan int rate may come down, which will reduce int. liability.
2. Expecting a return of 15% is very high.
3. We are not sure what return we will get from a SIP but we have to differently pay int on loan.
4. A calculation where you are assuming to pay @ lower rate and getting a return @ higher rate will always be exciting.
I think 4th point is the best explanation of the whole scenario. Clear, concise, general and irrefutable.
(1) It sounds interesting as pitched but if we plug in reasonable values we will be able to dismantle why this sounds so ‘exciting’.
(2) Lets assume more realistic annualized rate of return for the 17 year SIP to be: 10%
(3) Let us assume there will be the following costs on this SIP investment, making the effective rate of return as 9%
* LTCG would be 10.4% tax on the withdrawal
* Periodic rebalancing once in 2-3 years.
(4) So 4073 monthly SIP with an annualized 9% return yields 19.5 Lakhs in 17 years.
(5) That would not be sufficient to pre-close the loan outstanding 33.9 L
1. Achieving 15% annualized SIP returns over 17 years. Returns seems too aggressive target.
2. LTCG tax for realised SIP returns also to be considered.
3. Loan Prepayment penalty if any to be looked.
4. Extra home loan tax benefit for the first case(20 y tenure) as EMI is more than 2nd case(30 y tenure)
He’s ignoring the risk in investing in equity… you may very well end up worse. So you’re getting a higher return by taking risk. There’s no free lunch 🙂
Besides, if equity gives such good returns, why not skip buying the house and invest your entire money in equity?
Just one thought, what if we go thru recession from 10th to 17th year? Will we even have what was invested in those 17 years?