Would you want to prepay your home loan given the rate of interest is less than 9 percent and equities are outperforming?
Or you think it’s more rational to invest systematically in mutual funds and enjoy higher returns?
Well, there is a four-step strategy to help investors prepay their housing loan as well as accumulate wealth over time.
Step 1 – Invest one-third of the monthly housing loan instalment in the NSE Nifty 50 Index every month and do not withdraw the amount for the first three years.
Step 2 – Evaluate the portfolio after three years. If the return exceeds 15 percent on a compounded basis, withdraw all the amount that has been accumulated over the first two years. Don’t touch the money invested in last year as it can carry exit load. Use the proceeds to partly prepay the outstanding home loan.
Step 3 – Repeat the above steps and evaluate the portfolio after every two years, hereon.
Step 4 – After the loan is repaid, convert the monthly instalment, along with the original investment, into a monthly systematic investment in mutual funds.
Example – Imagine you had a home loan amount of Rs 60 lakh in 1990 with a duration of 20 years or 240 months. For Rs 60 lakh housing loan, you pay close to Rs 60,000 EMI per month and over a 20-year period you pay Rs 84 lakh interest. So, you took Rs 60 lakh housing loan but through EMI you are paying Rs 60,000 per month. So, over a 20-year period, you pay Rs 60 lakh plus Rs 84 lakh, which is Rs 1.44 crore you will pay to the housing finance company.
You have Rs 60,000 EMI. So, start Rs 20,000 SIP in NIFTY (for the sake of simplicity, we’ve taken NIFTY) and set the return target of 12-18 percent CAGR on the entire portfolio.
After 3 years, you look at how your SIP has done. Whenever you hit the 15 percent (the target you have in mind) you take out that money except the last 12 instalments of SIP and to that extent you pre-pay your housing loan. It is not necessary that you have 15 percent target in 36 months. Sometimes, it takes 48-60 months.
Evaluate your investment after every two years. Whenever you had this situation and hit the 15 percent level, you take the money out. On an average, it will happen twice or thrice.
If an investor has followed this strategy, and invested in NIFTY then a 20-year housing loan on an average gets repaid around less than 11 years
Potentially, you could have paid Rs 84 lakh of interest, but through this strategy you are paying only Rs 46 lakh and you are saving Rs 38 lakh. And hence, through this strategy you just paid 60% of the interest amount.
Now comes Step 4 – Once you repay the housing loan of 20 years in 11 years, after that there is no EMI. So, Rs 60,000 EMI then gets converted into SIP and your Rs 20,000 SIP continues. So, you have an SIP of Rs 80,000 p.m. and invest till completion of 20 year period and hence, over a period, it will end up creating a handsome amount of wealth for you.
This strategy was beautifully explained by IFA Mr Vijay Mantri from Buckfast Financial Advisory Services Pvt. Ltd. at the Mutual fund show (by Bloomberg). You can watch the entire show below –