Combination of EMI and SIP can save you lot of money
What if your Home loan tenure is reduced without increasing EMI, even if the interest rate remains the same? Sounds interesting? Read it.
In the year 2010, I bought a flat in Ahmedabad for which I took a home loan of Rs 48 Lacs from one bank. At that time the interest rates were around 10.5%. So I decided to take the loan for the maximum tenure available, i.e. 20 years as I could afford the EMI of Rs. 47922/-.
The bank RM came to my office for completing the paperwork. While filling out the forms he asked me about the tenure which I would like to go for. I told him to go for maximum tenure i.e. 20 years. Bank’s RM told me, “Sir maximum limit is not 20 years it is 25 years”. According to my calculation, I was ready for paying Rs 47992/, an EMI amount for 20 years of tenure considering 10.5% interest, and a Loan of Rs 48 Lacs.
So if I chose to go for 25 years, EMI would be lesser. I tried to do the exact calculation and ended up with some unique Ideas which I am sharing through this article. The EMI for the 25 years tenure was worked out to be Rs 45302/, resulting in the saving of Rs 2600/ per month in the EMI. So I decided to go for the longer tenure i.e. 25 years.
Now financially and mentally, I was ready to pay for Rs 47992/ of EMI per month. So I decided to start a SIP of this Rs 2600/- (saving in EMI due to increased term) and to use the amount accumulated through this particular SIP to repay the Loan in the future. I did some calculations in excel to check with the help of this combination of reduced EMI and SIP, how would it affect my loan repayment schedule.
My older SIPs were giving me some 18% kind of a CAGR, while doing the calculation I assumed that my future SIP would generate a 15% CAGR. I found out that with this combination and an assumed return of 15% CAGR from SIP, I can repay the loan in just 18 years and 2 months.
Let me explain,
Case 1: 20 years loan – Outflow (EMI – 47992)
Case 2: 25 years loan + SIP of saving into the EMI (EMI 45302 + SIP 2600 = Total 47992)
In both the above cases my monthly outflow is the same, the only difference is into the methodology. In the first case, I am only paying EMI in the second case by increasing tenure I am making saving into the EMI and doing the SIP of that saving, making my monthly outflow the same as that in case 1.
After 18 years and 2 months, the value of my SIP of Rs 2600/- per month assuming the 15% CAGR* would be approximately Rs 26.29 Lacs, which I can use to fully repay the Home Loan outstanding. In other words, the outstanding loan principle amount would equal to the Fund Value of SIP after 18 years and 2 months.
In the whole process, I would pay 22 EMIs less compared to Case one, making an absolute saving into the EMI worth Rs 10.54 Lacs. Though Bank charged me 10.5% interest for me the effective interest worked out to be only 10.03%.
If you are planning to buy a Home loan and if you have decided to take the loan for a shorter period then you can use the above idea to save some EMIs. So if you have decided to go for 15 years of tenure and your bank is ready to provide you maximum tenure of 25 years, I suggest you go for the higher tenure and utilize the monthly saving into EMI due to increased tenure to start a SIP into some good diversified equity mutual fund.
If you have already taken the loan you can still utilize the above idea by asking the bank to increase the tenure or you can also transfer your loan from one bank to another and while doing so, go for the maximum tenure.
I transferred the above-said loan to some nationalized bank at the time 22 years of tenure were pending in the earlier bank. I opted for 30 years of tenure in my second bank where I transferred my loan, further reducing my EMI. I added that saving also into the SIP and that would again save a few more EMIs.
Thus, selecting the maximum tenure and doing the SIP can help you repay your loan earlier. The return assumed in the above calculation is not the guaranteed return but I can safely assume that kind of return from SIP into my portfolio. My current portfolio has a CAGR of around 18%, while in the calculation I have assumed a 15% CAGR only.
*The return showcased is the assumed return and is not to be treated as any assurance or guarantee.