A reader who prefers anonymity asks, “I am planning to buy a house in the next few months. I have narrowed down on the property and locked in a price with the seller. I am using the proceeds of the sale of a property which was owned by my mother”.
“I have to arrange around Rs. 1.3 crores for completion of the sale. My wife and I are both working professionals, and our combined monthly income after taxes is around 3.2 lakhs. Together, we invest around Rs. 1.4 lakhs in MFs through SIPs. We live in rented accommodation for which the rent is Rs. 50,000. We have one nine-year-old child and would like to send him abroad for education. We have savings of around 70 lakhs in mutual funds and stocks”.
“My questions are as follows:
Option 1. Should I take a home loan of 1.3 crores with a 20-25 years tenure to finance the remainder of the requirement? OR
Option 2. Should I liquidate most of my savings (say 60 lakhs) and take a loan of 70 lakhs for a tenure of 15-17 years”.
I am getting differing advice regarding my questions. I understand that if I liquidate my Mutual fund savings, I will lose the compounding effect. But I will end up paying less interest on the home loan. I would be grateful if you could advise me on my conundrum”.
Warning and disclaimer: Our responses to reader questions are generic and is based only on the message received. There may be other factors that need consideration to appreciate the full context of the question and provide holistic advice. This is beyond our capability. We recommend readers consult a SEBI registered fee-only financial planner from our list for professional advice.
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Currently, the reader is investing more than 40% of total monthly income in mutual funds. Suppose they take a joint home loan for Rs. 1.3 Crores at an interest rate of 10% (to err on the side of caution and account for possible rate hikes) for 20 years, the monthly EMI will be about Rs. 1.25 lakhs.
Currently, for a normal home loan*, the EMI will be just above Rs. 1 lakh or about 30% of the total income – a comfortable level. See: When should I get a home loan? How do we decide this? Accounting for an increase in income in the coming years, even if the rate increases to 10%, the EMI will not cross 40% of the total income.
* We recommend a normal home loan instead of an overdraft home loan (like Max Gain). Just like insurance and investment should not be mixed, we see no reason why a mortgage and investment/savings should be mixed, plus the EMI will be lower. The time value of the extra EMI paid in the case of an overdraft account will diminish its “benefits”.
The key assumption here is that the new property is for self-occupation. Meaning, at current interest rate levels, about half of the EMI paid will come from the rent that no longer needs to be paid.
This means the monthly savings will reduce from Rs. 1.4 lakhs to about Rs. 85-90K. So still, about 25% of the total income will be invested, and it is not bad at all. If necessary, a small reduction in discretionary spending will also help.
The first option, “take a home loan of 1.3 crores with a 20-25 years tenure to finance the remainder of the requirement”, is just about possible. If, however, the EMI outgo seems too much or if the reduction in investment is hard to stomach, we recommend reducing the loan amount by a little (say 1 Cr or 1.1 Cr) using existing investments.
We do not recommend redeeming as much as Rs. 60 lakhs (second option) from existing MF investments. This would mean taking a loan for Rs. 70 lakhs, and the EMI will replace the rent with only a small extra outgo. However, most of the net worth will also be eaten up in the property purchase. This may impact their goal of sending their child abroad. Since he is already nine years old, there may not be enough time to rebuild a corpus.
A strong emergency fund and adequate health insurance are key to this plan. So we recommend putting this in place as soon as possible.
Implications: There are also downsides to any decision. Such a large home loan would require some time to get used to wrt monthly investments and expenses. More importantly, it means there is no chance of both partners retiring for the next 25 years. Even then, the retirement corpus will heavily depend on future income (assuming a good chunk of the present net worth is spent on the child).
This means want-based lifestyle changes in future will have to be sacrificed for some years to come. Thus there are risks here that are unpleasant to think about (e.g. our health may prevent us from working and increase recurring expenses). However, we recommend that the couple consider these before taking a plunge. These downsides are present in both options.
In summary, the couple should consider their long-term goals, future employability and growth in income before finalising the real estate purchase. We recommend that they consult a SEBI registered fee-only financial planner, get a retirement plan chalked out and then decide the home loan amount.
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