Finance is a critical factor in the purchase of property. It has become even more critical now with the high interest rates prevailing and the outlook uncertain for the equity markets. With the investment climate unpredictable, astute financial planning is the only way to ensure comfortable repayment of the home loan.
In a rising interest rate regime, home loan borrowers could use investment avenues such as equity and mutual funds to cushion the effect of higher EMIs. Strategic investments in systematic investment plans and even directly in stocks can be liquidated to prepay a part of the loan to keep the EMIs down when the interest rates go up. Prepayment helps in bringing down the overall cost of a home loan too. But in days of uncertainty and volatile stock market conditions, this avenue is risky as capital erosion is a major risk. For risk-averse borrowers this avenue is ruled out.
So what then is the recourse a home loan borrower who does not have a major appetite for risk take?
Debt options are yielding higher returns now with the successive hikes in the key policy rates by the Reserve Bank of India as part of its strategy to bring down the inflation rate. These key policy rate hikes, meant to cool down the demand-driven inflation rate, resulted in a monetary tightening that pushed interest rates higher for individuals – both deposit and borrowing rates. Consequently, debt instruments that are safer and right for risk-averse borrowers are offering higher returns.
These days, fixed deposits are offering over nine percent returns on terms between one and three years. These deposits are ideal to park surplus funds from time to time in, such as a bonus amount or maturity of another investment instrument.
The accruing amount (along with the interest) at the end of the deposit term can be used to make a part prepayment on the home loan.
This is an ideal avenue for those who find it difficult to invest a heavy lump sum at one go. Here, all you need to do is set aside a certain sum every month towards this deposit. At the end of the term, the amount along with the compounded interest can be used towards a prepayment on the home loan.
The advantage here is the amount can be as low as Rs 1,000 a month. The amount, however, needs to be higher to make a significant difference. A three-year recurring deposit scheme of Rs 1,000 per month can generate around Rs 40,000 at the end of the term that can be used towards a part prepayment.
Fixed maturity plan
This is a scheme offered by mutual funds. Here, the scheme has a fixed maturity date. The investor cannot exit from the scheme before that date. The advantage here is that this avenue is more tax-efficient for the investor with the facility of indexation available for longer terms.
This scheme, however, is not as secure as a fixed deposit in terms of predictable returns.
While making an investment – be it an equity-based one or a debt-based one – with the intention of generating a lump sum at a later date to be used to prepay a part of a home loan, it is important to take the tax implications into account.
Tax on returns can erode real gains at the end of the term. In avenues where the indexation benefit is available, the risk factor may be more. It is therefore mandatory for a borrower to understand his risk appetite well before venturing into equity-based instruments. However, if the corpus allows it, a balanced allocation to debt and equity can generate optimum returns for the borrower that will ultimately help in the management of higher EMI phases during the course of the home loan tenure.