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Navigating home loans can be tricky, especially when you’re trying to balance your financial future with what you can afford right now. With a home loan, your EMI often takes up a large chunk of your monthly budget, and the property only truly becomes yours once every payment is made.
So, how do you decide on the right loan tenure? How much should you put down as a down payment? And what about planning for future prepayments?
Emotionally, many people lean towards shorter loan tenures, eager to make lump-sum prepayments to close the loan early. But what if you looked at it from a different angle? What are the financial implications of taking a different approach?
Table of Contents:
Common perspectives on home loans
Common perspectives on home loans
Common perspectives on home loans typically include the following:
- Opting for a shorter tenure to save on interest.
- Making a substantial down payment to reduce the EMI amount.
- Planning to prepay the loan to eliminate the liability quickly.
But what if we flip these perspectives? Let’s explore the financial implications from the opposite angle, examining each of these common beliefs with supporting figures and considering the emotional aspects of these decisions.
Scenario 1
Common Perspective: Opting for a shorter tenure to save on interest.
Alternate Perspective: Choosing the maximum tenure.
While it’s common to opt for a shorter loan tenure to reduce interest payments and pay off the loan sooner, choosing a longer tenure can also have its advantages. A longer tenure reduces your EMI, freeing up additional funds that can be invested in a mutual fund via SIP, contributing to wealth accumulation.
Let’s assume you take a home loan of ₹60 lakhs with a tenure of 20 years at an interest rate of 9%. The Equated Monthly Instalment (EMI) would be ₹53,984.
Now, if you opt for a 25-year tenure instead, the EMI drops to ₹50,352. This reduction saves you ₹3,632 per month, which could be invested in a mutual fund via SIP.
| Loan Amount | ₹ 60,00,000 | Loan Amount | ₹ 60,00,000 |
| Loan Tenure | 20 | Loan Tenure | 25 |
| Payments per year | 12 | Payments per year | 12 |
| Loan Interest Rate | 9% | Loan Interest Rate | 9% |
| Monthly EMI | ₹ 53,984 | Monthly EMI | ₹ 50,352 |
| Total Cash Outflow | ₹ 1,29,56,054 | Total Cash Outflow | ₹ 1,51,05,535 |
| Principal | ₹ 60,00,000 | Principal | ₹ 60,00,000 |
| Interest | ₹ 69,56,054 | Interest | ₹ 91,05,535 |
| Difference in EMI | ₹ 3,632.00 | ||
| Investment Interest Rate | 12% | ||
| Tenure | 20 | ||
| Future Value of Investment | ₹ 33,40,922 | ||
| Outstanding Loan Amount after 20 years | ₹ 24,25,615 | ||
| Value of investment | ₹ 9,15,307 |
Assuming an annual return of 12% from an equity mutual fund, the value of this investment at the end of 20 years would be approximately ₹33.40 lakhs. This substantial corpus could help you achieve various financial goals.
You could even pay off the remaining loan principal of around ₹24.25 lakhs, with ₹9.15 lakhs still available for other objectives.
However, it’s generally advisable not to make prepayments towards the end of the tenure (as we will discuss in Scenario 3), so you might consider using this corpus for other financial goals instead.
Scenario 2
Common Perspective: Making a higher down payment to reduce the loan amount.
Alternate Perspective: Opting for a minimum down payment.
Typically, many people plan to buy a house and focus on saving for a substantial down payment, believing that a higher down payment will lower their EMI. However, if you opt for a smaller down payment and invest the difference, you could potentially build a significant corpus over time.
Consider a property worth ₹1 crore, where you initially plan to make a down payment of ₹30 lakhs. This leaves you with a loan amount of ₹70 lakhs, resulting in an EMI of ₹62,981 over 20 years at an interest rate of 9%.
Now, instead of paying ₹30 lakhs upfront, if you reduce the down payment to ₹20 lakhs and invest the remaining ₹10 lakhs, your EMI will increase to ₹71,978.
| Property Cost | ₹ 1,00,00,000 | Property Cost | ₹ 1,00,00,000 |
| Down payment | ₹ 30,00,000 | Down payment | ₹ 20,00,000 |
| Home Loan Amount | ₹ 70,00,000 | Home Loan Amount | ₹ 80,00,000 |
| Loan Tenure | 20 | Loan Tenure | 20 |
| Loan Interest Rate | 9% | Loan Interest Rate | 9% |
| Monthly EMI | ₹ 62,981 | Monthly EMI | ₹ 71,978 |
| Total Cash Outflow | ₹ 1,51,15,396 | Total Cash Outflow | ₹ 1,72,74,738 |
| Principal | ₹ 70,00,000 | Principal | ₹ 80,00,000 |
| Interest | ₹ 81,15,396 | Interest | ₹ 92,74,738 |
| Difference in Downpayment | ₹ 10,00,000 | ||
| Investment Interest Rate | 12% | ||
| Tenure | 20 | ||
| Future Value of Investment | ₹ 96,46,293 | ||
| Excess Interest | ₹ 11,59,342 |
However, the ₹10 lakhs invested in an equity mutual fund with an expected annual return of 12% would grow to approximately ₹96.46 lakhs over 20 years. This investment would then be equivalent to the original cost of your house.
While making a lower down payment increases your cash outflow and results in an additional ₹11.59 lakhs in interest payments, your investment value far surpasses this cost.
Essentially, the ₹10 lakhs saved from a lower down payment might cost you ₹11.59 lakhs in interest, but it would yield ₹96.46 lakhs over the same period.
Scenario 3
Common Perspective: Prepay and settle the loan.
Alternate Perspective: Avoid prepayment towards the end of the loan tenure.
Emotionally, many people prefer to pay off their loans as quickly as possible to be free from debt. However, continuing to service the loan until the end of its tenure can be more beneficial, particularly because the interest outgo is much higher in the early years compared to the later years.
For instance, consider a home loan of ₹60 lakhs with a 20-year tenure at an interest rate of 9%. The Equated Monthly Instalment (EMI) is ₹53,984. If you have already serviced the loan for 15 years, prepaying the remaining amount may not be as advantageous, as the bulk of the interest has already been paid.
| Loan Amount | ₹ 60,00,000 |
| Loan Tenure | 20 |
| Payments per year | 12 |
| Loan Interest Rate | 9% |
| Monthly EMI | ₹ 53,984 |
| Total Cash Outflow | ₹ 1,29,56,054 |
| Principal | ₹ 60,00,000 |
| Interest | ₹ 69,56,054 |
In the first 15 years, you would have paid off ₹34 lakhs of the principal, while the remaining ₹26 lakhs would be paid in the last 5 years. The interest paid during the first 15 years totals ₹63.17 lakhs, whereas the interest for the last 5 years is only ₹6.38 lakhs.
| Loan details after 15 years | |
| First 15 years Principal portion | ₹ 33,99,430 |
| First 15 years Interest portion | ₹ 63,17,610 |
| Next 5 years Principal portion | ₹ 26,00,570 |
| Next 5 years Interest portion | ₹ 6,38,443 |
This means that 90.82% of the total interest payable is already covered in the first 15 years. So, after having paid most of the interest, prepaying the loan towards the end may not be worth it.
A similar analysis can be done for prepayments made after servicing the loan for 10 years, which would yield comparable results.
| Loan details after 10 years | |
| First 10 years Principal portion | ₹ 17,38,447 |
| First 10 years Interest portion | ₹ 47,39,580 |
| Next 10 years Principal portion | ₹ 42,61,553 |
| Next 10 years Interest portion | ₹ 22,16,473 |
Conclusion
The decisions you make about your home loan can shape your financial future in significant ways. What if you chose a longer loan tenure and invested the difference? What if you minimized your down payment to seize investment opportunities elsewhere? And how about timing your prepayments strategically to boost your financial outcomes?
These approaches sound promising, but are they based on certain assumptions and risks? For instance, can you count on an equity investment to deliver a 12% annual return over the next 20 years? How do you manage these risks?
To navigate these choices wisely, isn’t it crucial to evaluate your options carefully and find the right balance between meeting your current needs and securing your financial future? It might be worth consulting a Certified Financial Planner (CFP) to help you make informed decisions tailored to your unique situation.
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