ARE LOANS BURDEN

It was quite difficult to believe when one of my friends said he didn’t believe in loans and didn’t even want to take a home loan for buying a house. He saves up money every month for his annual vacation and restarts the process. Am sure each of us have some or other friends who are extremely averse to borrowing. So, is it all that bad? If you are smart about the right decisions both on investment and borrowing, it is never bad. After all, all major business conglomerates do have loans in their balance sheets. By the way, the fundamental assumption here is that you’ll be smart in borrowing and will also pay back and not run away to Antigua or Nicaragua!

NEED BASED BUYING

The first step before deciding to borrow is to understand your current financial position. Assess your income levels and the needs. Remember the 50:30:20 principle? If not, read about it here. Essentially the first step towards consumption is your awareness about the real needs. The moment you see you consuming more than your income, it requires an immediate action, take some steps in controlling the expenses and you’ll be able to get back into shape within few months. With the current economic situation an opinion against consumption may attract strong nationalistic views, but yet it is important to be prudent. The country can borrow more than it earns, but as individuals we should never be in the situation. Assuming that you are prudent enough to manage your spends, lets look at some of the ways how you can weave the burden of loans into your investment strategy.

I AM PLANNING FOR A VACATION, CAN I SELL MY MUTUAL FUND

While my dear friend saves up a recurring deposit and plans his vacation, lets assume you have about 20,000 per month towards monthly investments (SIP) into some mutual funds and the same is earning about 16% per annum. Now it will be interesting to see how you can take a decision around your vacation. Imagine two persons, Pinky and Preeti facing this conundrum. Let’s assume both have been investing 20,000 per month and their current portfolio size is about 500,000. And they are planning for the vacation that will cost about 200,000. Pinky uses money from her existing portfolio and Preeti takes a Personal Loan at about 13% over 4 years. Assume both invest in the same mutual fund that is giving an annual return of 16%, here’s how their portfolio will look after 4 years: Please remember, Pinky continued to invest 20,000 per month and Preeti paid an EMI of 5,365 and invested the balance. Here is how they are looking after 4 years.

Preeti actually made more money after taking a personal loan for the vacation. See, taking a loan is not always a burden. Ok, here’s the catch. I have assumed 13% for the loan and 16% for the investment. If the return between your investment and loan is around this level, you can get a benefit from the loan. Consider this as a part of your investment portfolio and the moment you see the return coming down and if you are anticipating the same to continue for a longer period, liquidate some of the portfolio and pre-close the loan.

SHOULD I CLOSE MY HOME LOAN BY SELLING MY INVESTMENTS

Most of us have a home loan for a house where we live or get a rent out of it. One of the questions that keeps coming to us is whether it is prudent to close the loan from investment portfolio? Let’s use the concept as above and look at it it a little deeper. One important point is that the simulation below is as per prevailing market condition in India and the tax and market conditions may significantly vary when it comes to mortgages and home ownership in other countries. But the basic simple concept remains the same.

Preeti and Pinky have continued their diligent investments for 4 years after the vacation to Spain and they are sitting on an investment size of INR 4 million each. Now let’s assume they have a home loan of INR 3 million. Home loans India have been hovering at around 8.75% over the last few years and the let’s say the investments provide a 12% rate of return. Pinky follows her dad’s advice and closes the Home loan and invests the EMI value into monthly SIP. Preeti, being the maverick, continues to pay the EMI and allows her investment portfolio to grow. This is how their portfolio will look after 4 years.

Now I can hear you saying, the loan is for 20 years but we are comparing only after 4 years. What really happens during the entire loan period. This is how it is going to look after 20 years:

In India, you also get a tax benefit on the interest paid on home loan. The saved tax can again give you further benefit if invested or better still go for that Iphone11, instead of selling a kidney!

Just to simplify, I have assumed the EMI for the loan value of INR 3 million. If a larger loan was taken few years earlier with current outstanding of INR 3 million, then the EMI would be much higher. Also if you are earning a rent out of the property, then the return from the rental income is additional and I have not considered that here.

Again here as well, do keep a watch on the investment rate of return and the home loan rate of interest. If the gap is falling below about 2% do a detailed calculation and do some rebalancing. If you feel it is a temporary phase, then don’t worry, it will cover up over the long term, but if you are foreseeing any challenge in paying EMI or any other factors, do weigh them against the investment Trinity – Risk, Return, Liquidity. For a quick refresher in case you have forgotten, click here.

SO, CAN I BE ATLAS

Consider loans as a part of your investment portfolio and monitor their progress very closely. The moment your return on investment comes closer to the loan rate or lower, you need to immediately start closing your loans, starting with the highest rate. Please note, borrowing is a double edged sword and you need to read the terms and conditions before you sign-up for a deal. Do not blindly take a loan without reading the charges and other conditions; ask your advisor/sales executive about the method of interest calculation, etc and understand it thoroughly.

Remember, Antigua will not take common people like us as their Citizens. So a good credit history is like your reputation, build it and maintain it while you enjoy the fruits of the sweet burden called loans. You can indeed be Atlas, happily able to carry the burden.

Do share your views in the comments section. Do let me know if you feel the comparison work sheets will be useful, I can share simple calculators that can help you compare!

This is not an investment advisory. The intent is to simplify investment related concepts. Please seek professional advise before investing! Views expressed here are personal.

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