ET OnlineLooking to pay off your home loan ahead of schedule? Most experts suggest that you start by prepaying a part of your home loan principal amount early in the loan period. This can help you lower your future interest payments or boost your current EMI (equated monthly installment) to pay off the loan more quickly.
But is there a smarter way to pay off your home loan? Some experts, like CFP Kirtan A. Shah, recently proposed a radically different, albeit risky, strategy for quickly paying off your home loan in one of his LinkedIn posts.
Keep reading to learn about the potential risks of this approach and how you can effectively use it to pay off your home loans faster.
For instance, if you took out a home loan of Rs 80 lakh for 15 years back in August 2005, at an interest rate of 8.45%, your EMI would have been Rs 78,545. Over the 15-year loan tenure, you would have paid around Rs 61 lakh in interest, totaling over Rs 1 crore in both principal and interest to close the loan after 15 years.
Now, imagine you take the same loan amount of Rs 80 lakh but stretch it over 20 years. Your EMI would drop to Rs 69,173. However, you would end up paying around Rs 25 lakh more in interest during the loan period (Rs 86,01,496). But here’s the twist.
What if you invested the difference between the 2 EMIs (Rs 78,545 and Rs 69,173), which is Rs 9,372, in a mutual fund that tracks the entire Nifty50 index, through SIPs?
This means that in addition to paying Rs 69,173 as EMI, you would also invest Rs 9,372 in mutual funds. Check out your SIP corpus at the end of 2020 (after 15 years) and 2025 (after 20 years):
*Returns taken from Nifty50 TRI (2005-2020 for 15 years, 2005-2025 for 20 years)
As per data, between 2005 and 2020, the Nifty50 TRI yielded a CAGR of 10.12%, while between 2005 and 2025, the same index delivered a CAGR of 12.92%.
As a result, between 2005 and 2020, the value of Rs 9,372 invested monthly would yield Rs 38,25,361. With the outstanding loan balance at Rs 33,75,532, you would still be left with around Rs 4.5 lakh, even after paying off and closing the loan.
The same Rs 9,372 SIP, if continued for 20 years, i.e., between 2020 and now, would have zoomed approximately to Rs 96 lakh.
What are the risks of this strategy?
The single biggest pitfall of this strategy is that it might not work if your SIP investments aren’t increasing at a pace that’s faster than your home loan interest rate. Essentially, your ability to prepay the loan entirely depends on whether your investments can generate returns that surpass the costs associated with your outstanding loan balance. Given that there is no certainty in markets, the returns you have seen in the past might not reflect what you’ll earn in the future.
As CFP Shah also cautions, “past performance may or may not be sustained in the future and is not a guarantee of any future returns.”
Explains Abhishek Kumar, founder of SahajMoney, “This strategy has an inherent market risk, as investment returns may not exceed loan interest rates.”
However, this strategy will become more favourable for people who can claim tax deductions related to home loans, as their net cost of home loans will come down. “When combined with tax deductions available in the old tax regime on home loans (Section 80C for principal, Section 24 for interest), the effective borrowing costs go down, which might tilt the balance in favor of investments.” Even under the new tax regime, if it is a let-out house, you can get a deduction of up to Rs 2 lakh on home loan interest payments.
However, the key here is consistent investing. If you fail to invest in a disciplined manner, you would have to deal with poor returns in the initial period, says Kumar.
But is there a smarter way to pay off your home loan? Some experts, like CFP Kirtan A. Shah, recently proposed a radically different, albeit risky, strategy for quickly paying off your home loan in one of his LinkedIn posts.
Keep reading to learn about the potential risks of this approach and how you can effectively use it to pay off your home loans faster.
How does the EMI+ SIP strategy work towards paying off a home loan faster?
This strategy works well for anyone planning to start an EMI, like getting a home loan, or those who already have one, as Shah mentions in his post. If you currently have a home loan, you can refinance it and extend the tenure to make this happen. If you are considering a new home loan, you can opt for a longer tenure as well. This will help reduce your home loan EMI, allowing you to invest the savings into a mutual fund SIP.For instance, if you took out a home loan of Rs 80 lakh for 15 years back in August 2005, at an interest rate of 8.45%, your EMI would have been Rs 78,545. Over the 15-year loan tenure, you would have paid around Rs 61 lakh in interest, totaling over Rs 1 crore in both principal and interest to close the loan after 15 years.
Now, imagine you take the same loan amount of Rs 80 lakh but stretch it over 20 years. Your EMI would drop to Rs 69,173. However, you would end up paying around Rs 25 lakh more in interest during the loan period (Rs 86,01,496). But here’s the twist.
What if you invested the difference between the 2 EMIs (Rs 78,545 and Rs 69,173), which is Rs 9,372, in a mutual fund that tracks the entire Nifty50 index, through SIPs?
This means that in addition to paying Rs 69,173 as EMI, you would also invest Rs 9,372 in mutual funds. Check out your SIP corpus at the end of 2020 (after 15 years) and 2025 (after 20 years):
*Returns taken from Nifty50 TRI (2005-2020 for 15 years, 2005-2025 for 20 years)
As per data, between 2005 and 2020, the Nifty50 TRI yielded a CAGR of 10.12%, while between 2005 and 2025, the same index delivered a CAGR of 12.92%.
As a result, between 2005 and 2020, the value of Rs 9,372 invested monthly would yield Rs 38,25,361. With the outstanding loan balance at Rs 33,75,532, you would still be left with around Rs 4.5 lakh, even after paying off and closing the loan.
The same Rs 9,372 SIP, if continued for 20 years, i.e., between 2020 and now, would have zoomed approximately to Rs 96 lakh.
What are the risks of this strategy?
The single biggest pitfall of this strategy is that it might not work if your SIP investments aren’t increasing at a pace that’s faster than your home loan interest rate. Essentially, your ability to prepay the loan entirely depends on whether your investments can generate returns that surpass the costs associated with your outstanding loan balance. Given that there is no certainty in markets, the returns you have seen in the past might not reflect what you’ll earn in the future. As CFP Shah also cautions, “past performance may or may not be sustained in the future and is not a guarantee of any future returns.”
Explains Abhishek Kumar, founder of SahajMoney, “This strategy has an inherent market risk, as investment returns may not exceed loan interest rates.”
However, this strategy will become more favourable for people who can claim tax deductions related to home loans, as their net cost of home loans will come down. “When combined with tax deductions available in the old tax regime on home loans (Section 80C for principal, Section 24 for interest), the effective borrowing costs go down, which might tilt the balance in favor of investments.” Even under the new tax regime, if it is a let-out house, you can get a deduction of up to Rs 2 lakh on home loan interest payments.
However, the key here is consistent investing. If you fail to invest in a disciplined manner, you would have to deal with poor returns in the initial period, says Kumar.
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