One of the most significant financial decisions individuals make is purchasing a home, often necessitating a home loan to fulfil this dream. Once the decision to take a home loan is made, another critical choice arises—whether to opt for a short tenure and pay off the loan quickly or extend the tenure and invest the excess money saved in reduced EMIs in mutual fund Systematic Investment Plans (SIPs). Both approaches have their merits and drawbacks, and the decision depends on various factors.
Loan seekers keep on checking the loan calculators again and again for how much interest they will have to pay in different loan tenures. Even this exercise becomes futile, as they don’t reach any conclusive decision regarding the loan tenure.
Short Tenure: Swift Debt Repayment
This approach provides financial freedom and peace of mind for most people, as being debt free is of prime importance to most individuals.
Advantages of Short Tenure Home Loan:
Interest Savings: Short tenures result in lower overall interest payments, saving borrowers a substantial amount as far as interest is concerned.
Quick Debt Repayment: Home-owners can enjoy the emotional satisfaction of being mortgage-free at an earlier stage in life.
Long Tenure: Home Loan with Mutual Fund SIPs
On the other hand, choosing a longer tenure for the home loan and investing the excess money saved from reduced EMIs in mutual fund SIPs allows for a more balanced financial strategy.
Advantages of Long Tenure Home Loan with Mutual Fund SIPs:
Liquidity: Longer tenures result in lower EMIs, providing individuals with greater liquidity to invest in other avenues such as mutual funds.
Plan for Financial Goals: Investing prudently for financial goals will greatly increase chances to achieve them. As our most important financial goals are long term in nature and can only be achieved if we invest as per financial plan for more than 15-20 years. Investing less or starting late will derail us from achieving financial freedom. So we must not ignore to invest substantial amount regularly to fund our financial goals coming in future.
Potential for Higher Returns: Investing in mutual fund SIPs allows individuals to benefit from the power of compounding, potentially yielding higher returns over the long term.
Risk Diversification: Mutual fund SIPs offer diversification across various asset classes, reducing risk compared to concentrating all funds into home loan repayment.
Choosing the Right Path: The Balancing Act
The decision between a short tenure and a longer tenure with mutual fund SIPs depends on individual financial goals, risk tolerance, and liquidity needs & most importantly the emotional satisfaction of the individual.
The best strategy could be to combine short tenure & long tenure payment strategies together. You may decide a shorter payment period as per your cash flow & decide on an higher EMI (X) you may pay comfortably. You may then opt for a longer tenure loan with a reduced EMI (Y) & start SIP of amount (X-Y) in mutual funds.
After 7 years, you may opt to pre pay the longer tenure loan, as it was the original loan tenure desired by you. This will help you satisfy yourself emotionally & would benefit you financially too.
Let’s see how?, with the help of an example:
Suppose Mr Ram wants to get a home loan for Rs. 1 crore at the rate of 8.5% for 7 years with an EMI of Rs. 158365. He has chosen 7 years loan tenure, as he can pay an EMI of Rs. 158365 comfortably and wants to get debt free in a short span of time.
He met a financial advisor who advised him to opt for a 20 year loan with an EMI of Rs. 86782 and pre pay the loan in 7 years. But there is one condition that he will start SIP of Rs. 71583 (Rs. 158365 – Rs. 86782) in mutual funds simultaneously for 7 years.
Loan Tenure | Loan Principle (Rs.) | EMI (Rs.) | Total of EMI Paid (Rs.) | Outstanding Loan Principle after 7 Years (Rs.) | Monthly Investment in Mutual Fund SIP during 7 years (Rs.) | Total Investment in Mutual Funds | Mutual Fund Corpus in 7 years (Rs.) | Net Outflow (Rs.) |
| EMI * 7 * 12 | SIP | SIP*7*12 | @12% CAGR | Total of EMI Paid + Outstanding Loan Principle + Investment in MF – MF Corpus | ||||
7 Years | 10000000 | 158365 | 13302660 | 0 | 0 | 0 | 0 | 13302660 |
20 Years (Pre Pay in 7 Years) | 10000000 | 86782 | 7289688 | 8177914 | 71583 | 6012972 | 9229738 | 12250836 |
In the example above, if Mr. Ram would have opted for a 7 year loan then he would have a net cash outflow of Rs. 1.33 crore for a loan of Rs. 1 crore.
But in the case of a loan taken for say 20 years & prepaid in 7 years, he has to pay approx. Rs. 1.22 crore only. He may save approx. 11 lakhs in 7 years & get debt free at the same time which he had wished initially.
Explanation for longer tenure loan:
Cash outflow after 7 years = Total of EMI Paid + Outstanding Loan Principle + Investment in MF = Rs. 7289688 + Rs. 8177914 + Rs. 6012972 = Rs. 21480574
Cash inflow after 7 years = Mutual Fund Corpus = Rs. 9229738
Net Outflow after 7 years = Cash Outflow – Cash Inflow = Rs. 21480574 – Rs. 9229738 = Rs. 12250836 = 1.22 crore approx.
Conclusion
The decision to pay off a home loan in a short tenure or opt for a longer tenure with mutual fund SIPs is a complex one & influenced by various factors. Loan seekers must consider their cash flow, income projection & stability while deciding for a loan tenure. Paying a home loan along with a mutual fund SIP will ensure that you stay disciplined and pay importance to investing regularly. Also you must never forget to insure your loan which covers you in case something happens to you.
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