For many home loan borrowers, EMIs, or equivalent monthly payments, represent the largest single expense item. In many cases, the exposure to EMIs for home loans is detrimental to the investable surplus to meet long-term financial goals. Here are a few tips for home loan borrowers to secure their most important financial goals even as they continue to pay off their home loans:
Create a financial plan
Home loan borrowers should first create a financial plan based on their cash flow, risk tolerance, and investment horizon. This will help them achieve various financial goals and implement their asset allocation strategies.
Borrowers should first estimate the amount required to meet important financial goals after assuming a specific rate of inflation. Then, using online SIP calculators, calculate the monthly contributions required to achieve each of the financial goals after assuming the rate of return and investment horizon.
Invest in mutual funds for financial goals that mature after five years. The returns generated by equity funds generally tend to slightly outperform inflation and other asset classes over the long term. The automatic share purchase feature in SIPs on specified dates ensures financial discipline and regular investments. This can help you capitalize on the power of compounding and also ensure investment cost averaging during market corrections or bear market periods.
Invest in fixed deposits, debt funds, or other fixed-income instruments for financial goals with a five-year term to ensure income security and capital protection.
Down payments – not
Don’t use your existing investments for a higher down payment or to pay off the loan early. Home loan borrowers are required to make a down payment or margin contribution of at least 10% of the property cost for a loan amount up to £30 lakh, at least 20% of the property cost for a loan amount between 30 lakh and ₹75 lakh and at least 25% of the cost of the property for a loan amount of more than 75 lakh.
Higher down payments would reduce the loan amount and thus the overall interest cost for borrowers. Similarly, prepaying a home loan also helps in reducing overall interest costs. However, avoid liquidating your existing investments to pay off the loan early or make higher down payments as this could result in you taking out more expensive loans in the future.
Sufficient emergency fund
An emergency fund helps cover unavoidable or unforeseen expenses during a time of financial hardship due to illness or unemployment.
Without an adequate contingency fund, one would be forced to liquidate its existing investments and/or default on loan repayments.
Home borrowers should ideally consider their obligations to the EMI that are payable on loans when considering an appropriate contingency fund.
This protects them from defaulting on home loan repayments in times of financial distress. It will also save them from any negative impact on their credit score and future credit scores.
An emergency fund should be large enough to cover living expenses and unavoidable expenses like rent, insurance premiums, children’s tuition, EMIs, and the like for at least six months.
Borrowers can opt for a home loan overdraft while availing a home loan. This facility allows borrowers to deposit their excess funds into the overdraft account, which is opened in the form of a savings or checking account and linked to the home savings account. Borrowers can deposit their surpluses into the disposition account and withdraw them as needed.
The interest portion of the home savings account is calculated after deducting the credit on the overdraft account from the outstanding loan amount. This helps reduce their overall interest costs without impacting their liquidity.
(The author is Head of Home Loans, Paisabazaar.com)