HOUSING LOAN DILEMMA

April 5, 2018

Last week I was with a client of mine who works for an IT services company. He had just received a reasonable sum of money as his performance bonus for the year ending Dec 2017. Aged about 45 years, with a large home loan as well, his wife was insisting that he close the home loan with whatever funds he gets so that they are less stressed about the outstanding loan. As middle class Indians we have been brought up with this mindset that taking loans is bad and that we must, at the earliest opportunity, close such loans and learn to live within our means. This psyche is hardwired in our brains so much so that any loan gives one an uneasy sleep. So was the case for this gentleman. So when the wife suggested he close his loans, he was quite naturally inclined to do just that, however, since we were meeting up, he decided to wait up to take my advice and then move ahead.

The choice before this gent was to

 

  • Option 1: Part close the loan and continue the EMI payments as per originals to close the loan at an earlier date.

  • Option 2:  Part close the loan and readjust the EMI payments as so that the monthly payments reduce and the loan is repaid in the original term.

  • Option 3: Don’t close the loan and keep the lump sum invested in options that yield a better return than the cost of the loan.  

The loan was at an interest rate of 9.50% per annum (Floating Rate) and since the house was on rental, he therefore enjoyed the full interest set off, viz-a-vie the rental income.

 

Our Opinion:

 

Go with Option 3, invest the surplus in good equity large cap or balanced funds that would generate at least 12-15% per annum (over a 5 year term).

Since these investments are extremely liquid in nature, should there be a need, one can always liquidate the investments to generate liquidity.

Since the client was already used to paying the EMI, he should not stop or reduce the same but continue to repay using the EMI route.

Eventually in a 4 or 5 year’s time frame, the loan outstanding and the investment corpus could be nearly the same thanks to the growth in equity funds. It would make sense to use part of the investment corpus to close the entire loan.

 

In essence:

 

HOME LOAN IS A TAX ADVANTAGE LOAN, SO EVALUATE BEFORE YOU CLOSE IT. Example in a home loan rate of 9.50 % (the tax benefit for a 30% tax slab client would be 2.85 %, so the net cost of funds is only 6.65%per annum (any return above this is profitable to keep the loan going).

CLOSE IT WHEN YOU SEE NO FURTHER OPPORTUNITIES FOR DEPLOYMENT THAT WOULD GIVE YOU A BETTER RETURN.

 

Please note: the above would not apply to business loans, credit card loans or personal loans where the cost of funds are very high and do not enjoy the tax benefits.

 

 

 

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