SHOULD YOU PRE-CLOSE YOUR HOME LOAN OR INVEST
This will be the pop-up question for beginner to investment who has a home loan. Pre-closing the home loans or to invest. The interesting fact lying here is making people in double mind and never start to invest.
This topic will cover all permutation and combination of the new investors having loans, which eats their wealth. So, you will wear the same shoes and check whether to close the loans first or to start investments.
At end of the subject, you will come to know why you should close your loans on top priority by 10 years and having few investments side by side to create wealth over 20 years
PREPAYMENT OF HOME LOAN OR TO INVEST – TOP PRIORITY:
More than differentiating both the steps, you should focus on achieving both the things in equal parallel.
Home loans will erode your wealth, whereas invest grows your wealth.
· The foremost priority and focus should be towards pre-closure of home loans.
· At the same time, you should build an emergency fund. The other goal-based investments is not a compulsory one.
· The people who all have home loan should try to save a minimum 50% of their salary by completely avoiding their WANTS.
· If the home loan is the only debt they have, they should avoid all the future debt and have to close as soon as possible.
· Avoid unwanted expenses like, family trips, eating outside foods, frequent travels, over spending shopping’s, all materialistic dreams like Car, Big Inch TV, and most expensive appliances, until you close all your home loan debts.
· 100% focus of life should be in closing the Home loan debt and making our life debt-free.
The compound effect applies to everyone’s life. The compound effect makes people rich for those who invest and save. It makes the people poor, who keep on creating their debts.
HOME LOAN AND INCOME TAX:
Most people who are employees, opt home loans as a tax exemption tool. Currently, people can exempt their tax up to 3.5 lakhs in both the principle and interest they pay.
Unfortunately, there are many people who pays tax even after paying exemption loan interest and principle up to 3.5 lakhs.
We have written an article on Tax planning, where you can be tax-free up to 9.5 Lakhs even without a home loan.
Considering the fact above, you should pay to take only if get an annual pay of more than 12 lakhs. If you pay tax having a home loan, you should definitely book an appointment with a tax consultant and plan your tax exemptions.
You should invest 1.5 lakhs in Section 80C, where EPF will the main component, the rest of the amount should be invested in the ELSS scheme. Please have a look at ELSS VS PPF.
So, this ultimately makes an investment for you even you have a home loan.
HOW MUCH YOU SAVE IF YOU PRE-PAY THE HOME LOAN:
In this section, you will understand the benefits of closing the loans in 15, 10, and 5 years. Most of the home loans are taken for the tenure of 20 years.
Let me assume, an average home loan of 30 lakhs with 20 Years tenure for an interest rate of 8.5% per year.
Principle Amount – 30, 00, 000.
Interest to be paid – 32, 48, 327.
Total Amount after 20 years – 62, 48, 327.
Monthly EMI will 26, 035.
The calculation and documents were taken from HDFC Home loan Calculator.
1st Year – 2.52 lakhs Interest to pay & 0.59 Lakhs principle to pay
20th Year – 0.14 lakhs interest to pay & 2.98 Lakhs principle to pay
This is how every home loan works, as it has the pre-closure option. Initially, all your EMI deposits will cover the Interest amount only.
So, to reduce very quickly, you have to deposit more amount in principle amount which is apart from monthly EMI amount.
The loan amount we took here is 30 lakhs. To avail 30 lakhs home loan, minimum taxable income which is take home will be 10 lakhs a year.
Monthly income – Rs. 83,000.
Monthly EMI – 26, 035. So, the remaining amount – Rs. 56, 965.
Split this into four categories,
1. Basic NEEDS for life – Groceries, Vegetables, fruits, milk, water, electricity bill gas bill, Children education RD or Savings, term insurance, and medical insurance premiums, etc.
2. Emergency Fund – Of course, independent of the status of your life, you certainly need 6-12 months as an emergency fund. As a newbie to investment life, you will not be having an emergency fund.
3. Investments – If you still believe you can invest few amounts in Index equity funds and remaining you can deposit in a home loan.
4. Other funds – The total The remaining amount will be used as an additional amount to monthly EMI in closing the home loan as quick as possible.
Let us take this situational analysis into three categories and will find benefits over each scenario.
SCENARIO 1: An individual will only pay an EMI of Rs. 26035, Rs. 5000 for an emergency fund, NEEDS Rs. 40000, and 11,965 for Investment.
So, for Loan payment – 26305; Investment – 11,965.
SCENARIO 2: An individual will pay EMI of Rs. 26035 and adds Rs.5000 as per payment for loan closure, Rs. 5000 for emergency funds, Rs. 40000 for NEEDS, and 6965 for Investments.
So, for loan Closure payment – 31035; Investments – 6965.
SCENARIO 3: An individual will no invest any amount apart from an emergency fund of Rs. 5000 every month, Rs. 40000 for needs and remaining complete amount of pre-closure of the loan with the amount of Rs. 38000.
So, Loan closure payment – 38000; Investments – 0.
Will do a detailed analysis of two parameters:
1. How many years it will take to close the loan by each scenario.
2. At the end of 20 years, what will be the wealth created? Considering, once they complete the loans, the complete amount will be deposited towards the investment of a minimum of 8% returns per year.
ANALYSIS ON THREE SCENARIOS:
1. Scenario 1 takes 20 years to close the loan; Scenario 2 takes almost 14 years to close the loan; Scenario 3 takes almost 10 years to close the loan.
2. It is more important to get rid of the debt first.
3. When you could close your bank loan by 10 years and then invest the same amount for another 10 years will yield more than the amount of investing Rs. 11965 per month for 20 years at an 8% return.
4. The graph has shown clearly all three scenarios are contributing nearly the same wealth creation.
5. If you neither don’t invest nor don’t focus on pre-closure of home loan. Then your debt burden will still continue for 20 years without any wealth created.
6. The above three scenarios have resulted in the wealth creation of nearly 73 lakhs after 20 years.
7. Scenario 2 has saved almost 11.58 Lakhs compared to Scenario 1
8. Scenario 3 has saved almost 18 lakhs compared to Scenario 1, in term of interest to pay.
· It is important to have a mindset of investing, until you have this mindset this topic will be irrelevant to you.
· It is important in both the ways to pre-close the home loan and to invest at the same time.
· If you could close the home loan within 10 years and investing the same amount for next years, you can grow your wealth in many ways.
· It is most important to have all your NEEDS and to accumulate your emergency funds. Irrespective of your situation.