Being a homeowner is a much sought after life goal for many. This is especially true if an individual is a first-time home buyer
A home loan is probably the highest value loan an individual may take in his lifetime. Being a high value loan more often than not means that the loan will be of a longer tenure to result in an affordable EMI amount. There are money factors an individual considers before opting for a home loan such as:
What is an affordable EMI amount?
What is the correct tenure to opt for, throughout which he can sustain paying the EMIs?
Let’s take a look at availing a home loan of INR 50 lacs at the prevalent interest rate of 9%p.a. A loan tenure of 20 years will result in an EMI of INR 44,896 whereas a tenure of 30 years will result in an EMI of INR 40,231. The individual may be in quandary as to whether he will be able to afford such EMIs for the next 20 or 30 years especially if he envisions retirement within this time frame.
Is there any better alternative to paying such high EMIs?
Well, what if you could fund the EMIs of your home loan at a fraction of the above cost? You can, through Systematic Investment Plans (SIPs). If planned well, SIPs can help you pay off your home loan. Let’s look how this works:
Dual strategy of SIPs and SWPs:
The key here is to begin an SIP as early on in your career as possible. Though you may not be able to afford a high EMI immediately, start an SIP as soon as feasible. The longer the duration of the SIPs, the easier it will be to fund your EMIs. This does not necessarily mean that you need to have high value SIPs in place for decades to make this possible. Consistent and sustained SIPs over a reasonable tenure is vital.
Once you have a reasonable investment corpus in place, you can begin withdrawing amounts to fund the EMIs through Systematic Withdrawal plan (SWP) while continuing to contribute to the fund through SIPs.
Assumed a conservative amount as SIP to begin with, to establish that you needn’t have very high value SIPs to fund your EMIs.
SIP for initial period before opting for home loan:
Home loan availed after 5 years:
SWPs to pay EMIs:
Once the home loan is availed, an EMI of INR 44,986 would have to be paid each month. Instead of paying this amount outright, the escalated SIP can be continued each year and the EMI amount can be withdrawn from this accumulated investment corpus through an SWP.
At the end of the loan tenure:
In this example, at the end of the loan tenure not only is the loan completely paid off through SIPs but the investor can be also left with an amount of INR 10,83,375 in his investment corpus.
An interesting point of comparison is the amount of money saved by funding EMIs through SIPs and SWPs:
Effectively the loan amount of INR 50,00,000 has been repaid by a net outflow of INR 86.52 lacs through SIPs vis-à-vis INR 1.08cr through outright payment of loan EMIs. Which can be Resulting in a saving of INR 21.44 lacs
Factors that contribute to this benefit:
EMI remains the same (fixed interest rate loan EMIs assumed) throughout the loan tenure of 20 years, whereas SIPs although may begin at a low amount, can be stepped up each year as per affordability. In our example, considering a conservative annual accretion of 5%, the SIP which began with INR 17,000 per month in Year 1 reaches INR 54,827 in the 25th year. (initial 5 years plus 20 years of loan)
EMI is formulated considering an interest rate of 9%. SIPs in equity funds when invested over a long period (in the case of this example – 25 years) can reasonably be expected to earn a return greater than that.
The above 2 factors coupled with the benefit of compounding that SIPs enjoy contributes to the cost effectiveness of this option.
While investing in equity funds comes with no guaranteed returns, beginning to invest at an early age puts you on the right path to achieve your financial goals. For funding long term goals such as buying a home, equity mutual funds can be opted for as they have potential to give good returns in the long run and SIPs is one of the ways to do this as it inculcates financial discipline as well as gives investors the benefits of compounding. SWPs can be utilised subsequently to withdraw funds from SIPs to fund financial goals.
Information and computations mentioned in the working are on a broad level and investors are advised to consult their tax advisors for their individual tax implications.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.