But, if instead of paying home loan EMIs that can typically be anything between Rs. 20,000 to Rs. 30,000, we ask the same individuals to invest the same amount in mutual funds every month via a Systematic Investment Plan or SIP, then instead of readily agreeing to it, there would be a lot of hesitation. Why is it that millions of us pay significant chunks of our salary for EMIs, but can never pay a similar amount for mutual fund investments? What if we tell you that investing a similar amount in mutual funds, would in fact, give much higher dividends than a home loan ever could, in the long run? But how? Let’s find out.
What is a home loan and how does it work?In a home loan, a person can borrow funds from a bank or a Non-Banking Financial Company (NBFC) for the purpose of purchasing a home. The lender, after thoroughly verifying the borrower’s repayment ability disburses the loan amount. Understandably, the loan amount is never the entire cost of the home. A part of the house cost, usually about 10% or 15%, has to be paid as a down payment by the buyer. Once the loan is disbursed, the borrower has to start repaying the loan with monthly payments called as Equated Monthly Installments or EMI. Every month, the borrower must dutifully pay the EMI to the lender for the entire tenure of the home loan, which can typically be as long as 15 or 20 years or even more.
Here comes the interest, where the lender will make money by giving out the loan. The lender charges interest rates between 8% to 10% per annum on the entire loan amount. When you pay the EMI, part of it goes towards the interest and the remaining part goes towards the principal amount. Thus, at the end of the home loan tenure, what you end up paying for the home is considerably higher than the original cost of the house. Add to that the stamp duty charges and registration fees, and the eventual home cost goes even higher.
How is home loan an investment?Purchasing a home or any other property is almost an investment, and a good one at that. The simple reason is that the price of a house will eventually go up in the long term. A house or a property is deemed as an ‘appreciating asset’, which means your house will cost a lot more after ten years than it does now. Yet another reason is the ability of a property to generate passive income. A passive income is a type of income that you can get without actively doing anything.
You can retire and just receive the passive income. Owning a property means that you can rent it out if you yourself are not using it. Therefore, you receive the rent for your property every month, thus generating passive income. So yes, getting a home loan and purchasing a home is considered a good investment option.
Prepayment of a home loanWhen you take a home loan, there is an option to prepay the home loan before the tenure is over. Maybe you get a hold of some extra money or receive a bonus at work. You can make use of this extra fund to prepay your home loan. Prepayment of a home loan is considered a good ‘investment’. Why? Because you save up on interest. Lenders charge interest per annum, which means the longer your loan tenure runs, the higher will be the interest you eventually pay.
When you prepay your home loan, your tenure period will be shortened by a few years, thus bringing down the annual interest. But prepaying your home loan is still not a better investment than mutual funds. So, the question arises, if you receive some extra cash, which is better, prepaying your home loan or putting that extra money into mutual funds? We’ll get to the answer shortly. First let us understand what mutual funds are exactly..
What are mutual funds?Mutual funds are pooled funds that are collected from many investors, assimilated together and are invested into stocks, bonds and other assets. Mutual funds are usually managed by special money managers, who decide where they want to invest in mutual funds based on the market status. The aim of the money managers is to invest the pooled funds such that the investors gain some profits.
What is SIP?SIP is short for Systematic Investment Plan. It is a structured process that allows one to invest in a mutual fund, where one can invest on a monthly basis, in a regular manner. Instead of investing lump sum amounts into mutual funds, SIP facilitates a person to invest a fixed amount every month towards a mutual fund. Investment in SIP can be done for very less amounts but the best way to grow your fund is to invest for a longer duration. So, when it comes to paying out monthly amounts as an investment, SIP sits right up there with an EMI and can be more advantageous.
How SIP can be a better investment than home loan: Home loan vs mutual fundAs discussed before, an SIP investment into mutual funds can give off significantly higher dividends than a home loan. Let us consider an example to get a clearer picture.
Suppose you plan to buy a house that costs Rs. 37.5 lakh and you get a home loan for it. Lenders usually ask for down payment that is about 20% of the cost of the house. Therefore, you pay Rs 7.5 lakh as down payment and get a loan for the remaining Rs. 30 lakh with an interest of 10% per annum and a loan tenure of 15 years.
Any good online EMI calculator will show you that for this particular loan, you will have to shell out an EMI of Rs. 32,238. Add to that the registration costs of the house, which can be about 20 percent of the house cost, which in this case will be about 7.5 lakh. Thus, for a house that originally cost Rs. 37.5 lakh, you’re paying an actual cost close to Rs. 73 lakh, when you add together the down payment, the total number of EMIs and the registration costs.
Now let us consider that instead of paying out the EMI of Rs. 32,238 for your home loan, you pay out the same amount for a mutual fund investment via SIP every month. To make matters real, let’s say you do not own a house and have to pay rent of Rs. 10,000 out of the Rs. 32,238. Thus, you are left with Rs. 22,238 to invest in SIP every month. Assuming that you invest this money every month for 15 years, plus you also invest the down payment and registration fees which comes down to Rs 15 lakh as a lump sum amount, your returns after 15 years will be close to Rs 4.28 crore, which is a whopping 20 percent return.
Even if we consider that your house cost of Rs 37.5 lakh appreciated 10 times over the last 15 years, it will still cost Rs. 3.75 crore, which is less than what you achieved with your SIP amount including Rs 10,000 for rent. It is also worth mentioning that assuming a ten-fold appreciation of a property is merely pushing and may be unlikely. Therefore, even after investing a lesser amount in mutual funds, after the same period of investment, your mutual fund corpus will still be considerably larger than the value of your property. If you want to check for yourself how your specific home loan fares against a mutual fund, you can use a home loan vs sip calculator available online.
Final wordIt is clear from the above example that if you invest an amount that is similar to your home loan EMI into mutual funds via SIP, you are making a much better investment and getting higher returns. Even then, individuals are much more hesitant to put the same amount into SIP but are enthusiastic to put it into home loan EMIs. Maybe it has something to do with the psychological advantage that they will be homeowners. A bit more consideration will make it clearer that investing in mutual funds is a much better investment option when compared to home loan investment.
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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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