Should I redeem investments and reduce my home loan burden as much as possible?

A 32-year-old reader asks, “Should I redeem investments and reduce my home loan burden as much as possible?” This is the comparison he sent us.

“Cost of land: Rs. 70 Lakhs (including registration). Cash in hand: Rs. 50 lakhs. If I get a home loan for Rs. 50 Lakhs, I would be left with Rs. 30 Lakhs cash after the property purchase. The EMI at about 9% interest will be Rs. 45,000. If I invest the Rs. 30 Lakhs at 8% interest, I will get Rs. 20,000 monthly. So, my effective EMI outgo is only Rs. 25,000. This is 40% of take-home pay, and I can afford it. Does this make sense, or do I need to go ahead and spend the 50 Lakh I have saved fully and take a minimal loan to afford this property? Note: I was saving a separate amount to construct the house in the next five years and consider it a separate goal.”

There are three issues in this comparison.

1. As they say, personal finance is personal and is missing in this calculation – the person.
2. Assuming 8% year on year (before tax?) is wrong. You don’t get that anywhere without risking capital.
3. Subtracting that interest from your EMI and claiming the reduced EMI is affordable is wrong unless you will receive that interest in hand each month. In this case, it would be a massive waste of that capital. So I am not sure if you can afford a Rs. 50 lakhs EMI.
4. The “cash” you do not use for the home loan should be invested for long-term goals. The EMI should be considered as such without any reduction.

We recommend the following:

1. First, plan for your long term goals like retirement and (when relevant) your children’s education, etc. Find out how much you need to invest for these.
2. Then, allocate some of your current assets (Rs. 50 lakhs plus other investments) to these goals and some to the plot purchase.
3. Find out how much the investment required for goals and the EMI varies as the above allocation changes.
4. Choose some allocation (e.g. 25 lakhs to long term goals and 25 lakhs for a home loan. Similarly, with your other investments except the money allocated for house construction) such that you can manage the EMI with your take-home pay and leave room for investments.
5. Create a cash flow projection of your salary, expenses, EMI, and investment and see how you fare year on year. See: Why a cash flow projection is essential for financial planning.
6. Once the home loan starts, don’t hurry to pay it off. Balance investments, debt and expenses wisely.
7. After your home loan is over, you should aggressively compensate for the time and money lost by investing more for retirement and other long term goals. So do not add further dreams and wants to the equation!

Wish you all the best.