EMI vs SIP
The EMI TRAP
Mr.Financial Advisor : Good morning Sir, Tell me about your plans for buying that 3 bedroom flat.
Mr. Client : My salary is Rs 1,00,000. The total cost of my flat is Rs 75 lakhs. I have planned to pay a down payment of Rs 25 lakhs take a home loan of Rs 50 lakhs for 20 years and my EMI will be Rs 50,000 per month.
Mr.Financial Advisor : Great. And what about your current monthly expenses?
Mr.Client: Currently, my expense is Rs 30,000 monthly and I can save an extra Rs 10,000 when my car loan EMI is over.
Mr.Financial Advisor : So, just calculate how much percentage of your savings will into paying EMI.
Mr.Client: around 85%.
Mr.FA : That is my worry. You are putting all your eggs in one basket, i.e. in Real Estate.
Mr.Client: But, it is necessary, I will save tax on this and our society demands me to "Own a house".
Mr.FA : Oh, what tax will you save on Rs 2 lakh interest of home loan (As per IT rules, you can claim Rs 2 lakhs per year as a deduction)? You are in the 30% tax bracket, so you will save 30% of Rs 2 lakhs, ie, Rs 60,000 tax per year.
Mr.Client: Yes.
Mr.FA : But Mr.Client, at the cost of interest of your home loan, your EMI is Rs 50,000 for 20 years. That means, you will be paying Rs 50,000 * 12 * 20 = Rs 1.2 crores to the bank against your loan of Rs 52 lakhs.
Mr.FA continues to explain: Rs 1.2 crores - Rs 52 lakhs = Rs 68 lakhs of interest you will pay for 20 years. That means you are paying Rs 3.4 lakhs interest every year and you save Rs 60,000 tax every year. So, your total loss interest expense is Rs 3.4 lakhs - Rs 60k = Rs 2.8 lakhs.
Mr.Client: I never thought it in this way.
Mr.FA : If you would have invested this Rs 50,000 through SIP in good Stock/Mutual Fund for 20 years at the rate of 13% CAGR, you would have accumulated Rs 5.8 crores.
Mr.Client: What about the Rs 25 lakhs down payment?
Mr.FA : At a rate of 13% CAGR, it would become Rs 2.8 crores in 20 years.
Mr.Client: Meaning a total of Rs 8.6 crores. My Rs 75 lakh flat for which I will be paying Rs 1.2 crores will never give me a return of Rs 8.6 crores in 20 years.
Mr.FA : Exactly my point. Don’t just take a home loan to save tax. Dont buy a house just because of society compulsion. "Invest in real estate only if you have surplus money and able to find cashflow positive properties".
Mr.Client: Let me rent this flat and make good returns and wait for the property to appreciate.
Mr.FA : Sir, Even if you assume 22,000/- rent for this 75 lakh property, it works out to just 3.5% annualised returns which is less than a Bank Fixed Deposit. The loss occured by the low rental yields is very tough to compensate after few years even if the property is appreciating.
Mr.Client: Ok. I got it. Thank you Advisor . You saved my money........
Mr.Financial Advisor : You are always welcome Sir.