MYTH OF SHORT TERM HOME LOAN VS FACT OF LONG TERM HOME LOAN
(By CA Rajesh Garg, Assistant Director, Ministry of Finance)
Hello Friends, in this article we will analyse that how Home Loan of 30 Lakhs for 15 Years means losing of Rs.80 Lakhsas compared to 30 years Home Loan of same amount, apart from other implied financial benefits.
OBJECTIONABLE!!! LET’S EXPLORE THE DETAILS
I know you have been advised by all including Family, Friends, Colleagues, Seniors etc. that keep the Home Loan shorter. They always tell that interest burden in case of Long Term Home Loan is very high as compared to Short Term. Indeed they are right on this aspect, for instance in case of 15 years interest cost @8.5% P.a. is only 23 Lakhs while in case of 30 years interest cost is 53 Lakhs!!! Even then we would prove that Long Term Home Loan is far better than Short Term for overall FINANCIAL PLANNING, as THEY HAVE IGNORED THE OTHER SIDE OF COIN i.e. To Know Please Hold Breath.
CONFUSING!!! LET’S BUILD CONCEPTS FIRST
To reach out conclusion, let’s first understand various concepts involved in world of Home Loan having financial impact.
Let’s First Assume
Ram (An Emotional Personality): Take Home Loan for 15 Years
Shyam (Practical & Calculative Personality): Take Home Loan for 30 Years
Tax Saving on Interest Paid on Home Loan: To encourage Home Buyers, Government provides incentive to Home Buyers in the form of Tax Savings on interest payment. As per Section 24(b) & Section 71(3A) of Income Tax Act, actual interest payment up to Rs.2 Lakhs in each financial year can be adjusted from your salary income. This results in low tax payment. In other words, effective cost of interest payment is reduced to the extent of Tax Saving on Interest Payment.
Investment of EMI Difference: To make it a comparative study, cash outflow must be equal in both the cases over the period of 30 years. EMI amount is Rs.29,542 in case of Ram (15 Years Term) and Rs.23,067 in case of Shyam (30 Years). So, difference of Rs.6,475 per month is required to be invested by Shyam till 30 years. Similarly from 16thYear Onwards when there is no EMI in case of Ram, Rs29,542 per month is required to be invested by him till 30 years.
Feeling Burden of Investment!!! Be Disciplined & Make it a Habit
Please don’t feel burden of investment rather make it a habit to enjoy retirement life called 2nd inning of life with self-respect & dignity. In Investment Management, Compounding Effect (interest on interest) is called 8th Miracle of the World. It makes Early start of regular investment even of minuscule amount is far better than bigger amount at later stage. So, timely investment helps you to build good retirement corpus along with maximisation of returns on your money.
Investment can be made as per Risk Profile of Investor for instance in Risk Free securities like PPF, Postal National Saving Certificates etc. or in Stock Market-Mutual Fund SIP.
Public Provident Fund (PPF): PPF is a saving scheme backed by Government of India. In PPF account, Principle amount deposited can be claimed as deduction under section 80C and interest income on PPF is also exempt from income tax under section 10(11) of Income Tax Act. At present rate of interest is 7.6% p.a. and maximum deposit limit in PPF is Rs.1,50,000 per annum. As interest income is exempt, effective interest rate is also 7.6%.
Stock Market-Mutual Fund SIP: It is an accepted fact that investment in Stock Market carries financial risk of losing money or not earning return as expected. At the same time it is also a reality that risk can be managed by professional approach, diversifying the portfolio among multiple securities and having Long Term Perspective (Principle of Longer the Horizon, Lesser the Risk). It should be kept in mind that market can fluctuate downwards in short term like for three to five years, but in long term like ten to fifteen years, it must have positive trend. (For instance, Market in 2004 was 6602 points, fluctuates upward to 20,286 in the year 2007 and then downwards to 9,647 in the year 2008, but at end of 10 years i.e. 2014 it closes at 27,499 giving average annual return of 15%). As Market is an indicator of economy’s performance and strength, it is not possible that market runs downwards for such a long period because if it happens then “GOD GIVE US STRENGTH TO SAVE OUR COUNTRY”.
As Mutual Fund provides professional approach along with huge amount of fund to diversify, we suggest every month investment through Mutual Fund-SIP of ELSS category which qualifies for deduction under 80C also. Mostly mutual Funds have provided handsome return over last twenty years, it is more than 15% (Source: Economics Times, link provided at the end). Since Budget, 2018 has imposed tax of 10% on such return from mutual fund; effective return comes around 13.5%. We have taken 12.5% return in our analysis as a conservative approach.
Liquidity is an Asset Itself: In simple terms Liquidity means money readily available for use. In Financial Management Liquidity is a very valuable asset in itself. It helps in managing the Emergency Situations, Unplanned Expenditures or Grabbing Investment Opportunities comfortably. In case of absence of liquidity these exigencies would be required to be managed from costly sources like Personal Loans or Credit Cards apart from creating stress in life.
National Saving Certificates (NSCs): NSCs are issued by Post Office. If a person wants investment only in so called risk free securities, he has to search for other alternatives apart from PPF, in case his Investment is more than 1,50,000 P.a. (maximum investment limit of PPF in a year). NSC is best option available after PPF which gives interest rate comparable to PPF i.e. 7.6%. But one catch is there that in case of NSCs interest income is taxable so effective interest rate is 5.32% only. Ram would have to opt for this low interest income option along with PPF as from 16thyear his investment would be Rs.3,54,506 p.a., while Shyam investment would be only Rs.77,697 P.a for 30 years.
ENOUGH CONCEPTS!!! LET’S EVALUATE CONCLUSION NOW
Scenario-1: When Investment is done in Mutual Fund:
Analysis: While Cash Outflow is equal (i.e. Rs. 1.06 Cr) over the period of 30 Years in both cases but Cash Inflow of Shyam at the end of 30 years is more than Ram by an amount of Rs.81.65 Lakhs.
Reasons: Due to Compounding Effect, while investment of Shyam of Rs.23.30 Lakhs only (Rs. 6,475 per month for 30 years) becomes worth Rs.2.21Cr at the end of 30 years. On the other hand investment of Ram of Rs.53.17 Lakhs (Rs.29,542 per month for 15 years) becomes only Rs.1.47Cr. (Ram Losing Rs.73.70 Lakhs on this account).
Another losing ground of Ram is Tax saving on interest paid. While Ram will get tax saving of only Rs.6.49 Lakhs, Shyam will get Rs.14.42 Lakhs. (Ram Losing Rs.8 Lakhs on this account).
Besides these financial benefits, Risk of Shyam’s investment in mutual fund is much less as compared to Ram, as his time horizon of investment as compared to Ram is very long. (Longer the Horizon, Lesser the Risk).
Scenario-2: When Investment is done only in Risk Free Securities:
Analysis: Against the perception of Short Term Home Loan, even in case when both decides to go for only risk free investment, Ram is a disadvantage position by Rs.5.5 lakhs in comparison to Shyam.
Reason: There is tax saving on Interest paid, while PPF interest income is tax free. Also Ram has to invest portion of his investment in NSCs which has effective rate of interest (5.32%) less than PPF (7.6%).
Besides Financial Advantage, Shyam will also enjoy major benefit of Liquidity for instance at the end of 15 years when Ram has zero liquidity, Shyam has liquidity of Rs.21 Lakhs as PPF Balance to meet any exigencies or emergency situations.
Conclusion: It can easily be concluded from above analysis that Long Term Home Loan is far better than Short Term Home Loan on both Financial Parameters and Liquidity Management point of view. Only Pre Condition is you have to be disciplined & punctual to invest difference amount every month which can easily be imbibed by subscribing SIP of Mutual Funds.
Before Ending I would like to reiterate again that though it is said mutual fund investment is subject to market risk but investment for such long horizon does not carry any material market risk. Even still you are hesitant then you can go for 50:50 (SIP: PPF), then also you will be beneficial by Rs. 40 Lakhs apart from having handsome amount as Retirement Corpus. In case of any personal querry, you are invited to ask on our facebook page:
Happy Learning!!! PLAN YOUR MONEY WITH CAUTION LIKE SHYAM
Views are Personal, may not suit individual financial perspective.
Does not have any interest to promote business of Banks or Mutual Funds.