There's a loan available for almost anything today. You can avail a loan to purchase your dream home or car or white goods. You can even use a loan to go on a vacation. The apparently attractive feature of all these loans is that you repay them in small Equated Monthly installments or EMI.
But think again. Suppose you were to take a home loan of Rs 50 lacs at 9.35% for 20 years, you would have to pay an EMI of approx. Rs. 46,000. Do some simple maths and you will realize that you are repaying Rs. 1.10 crores for a loan of Rs. 50 lacs!!
Now, does this type of EMI still seem good? Not anymore.
So, the next question is- Is there something like a good EMI and if so, how can one lock into it?
The simple answer is- start a Systematic Investment Plan (SIP). An SIP is what we like to call GOOD EMI. It will help you achieve your future goals, like buying a home, in a shorter span of time and reduce the total interest outflow.
Now, let's take a look at what SIPs are, the benefits that accrue and why it can be called good EMI.
- SIP is a disciplined way of investing a fixed sum regularly in a mutual fund scheme.
- It allows you to invest in a MF scheme by making smaller periodic investments of as little as Rs. 500 per month. Hence, it is also light on the wallet.
- By investing a small amount via SIP, even a common man can now participate in equity markets or own equities. One can expect a return of 12% to 15% p.a. in the long run (15-20 years) from equity mutual funds.
Let us take an example of Mr. A and Mr. B.
Home Loan: Mr. A and Mr. B- both have taken a home loan of Rs. 22 lacs to buy their dream home. The interest rate is fixed 9.35% p.a. for a tenure of 20 years and the monthly installment comes to approx. Rs. 20,300 for both of them. The interest cost for 20 years works out to approx. Rs. 26.70 lacs.
Now suppose Mr. B would like to repay the loan amount in 10 years, the EMI would increase to approx. Rs. 28,300 p.m. However, he is not in a position to increase the EMI by Rs. 8000 p.m. and only has Rs. 5000 to put away as of now.
So, let's say he started a SIP of Rs. 5000 p.m. in an equity mutual fund and is able to increase the SIP amount by 10% every year. This way, the corpus accumulated in the scheme after 10 years will be approx. Rs. 16.87 lacs, which he can use to repay the outstanding loan of approx. Rs. 15.78 lacs amount in 10 years.
- Here are all the benefits that accrue:
- INTEREST COST SAVED: Rs. 8.56 Lacs
- EXCESS CORPUS GARNERED FROM SIP AFTER REPAYMENT OF LOAN: Rs. 1.09 Lacs
- TOTAL GAINS: Rs. 9.65 Lacs.
Also, he is able to achieve his goal of buying his dream home and clear the loan liability in 10 years instead of 20. This is a perfect example which depicts how SIP = GOOD EMI.
Car Loan: Let us take another example of an individual who wants to buy a car which costs Rs. 5 lacs. If he opts for a car loan, the interest rate is 10% p.a. for a tenure of 5 years and the monthly installment comes to approx. Rs. 10,600. This translates into an interest cost of approx. Rs. 1.37 lacs over the five year period.
Instead, if he postpones his decision to purchase a car by 5 years and starts a SIP (i.e. he pays good EMI) of Rs.10,000 p.m. in a Balanced fund, he will accumulate a corpus of approx. Rs. 7.80 lacs after 5 years. This can be used to buy a car that costs more. Till he has his own car, he can use car rental services or an app based cab service for important days when you need a car.
Hence, INTEREST COST SAVED: Rs. 1.37 Lacs and he is able to achieve his goal of buying a car.
Vacation Loan: Let us take yet another example of a lady who wants to go on a dream vacation, which would cost her Rs. 10 lacs. If she opts for a loan for the same, the interest rate would be 17% p.a. for a tenure of 5 years and the monthly installment payable would be approx. Rs. 24,800. The interest cost for 5 years comes to approx. Rs. 4.90 lacs.
Instead, if she postpones her decision by 5 years and instead starts a SIP (here again, she pays good EMI) of Rs.25,000 p.m. into a equity fund, she will have a corpus of approx. Rs. 20.60 lacs after 5 years which she can spend on a dream vacation, and pay for her spouse as well.
Hence, INTEREST COST SAVED: Rs. 4.90 Lacs and also she is able to achieve her goal of going on a dream vacation with her loved one.
Note: For a time horizon of more than 5 years, as in the case of the purchase of home, one should invest in equities and expect a return assumed of around 12% p.a. For a time horizon of 3 to 5 years, one should invest in a balanced fund and expect a return of around 10% p.a.
- 1. By avoiding loans and delaying the goals, you are able to save on your interest outflow.
- 2. Invest in equity funds for a time horizon of more than 5 years and balanced funds for a time horizon of 3 to 5 years.
- 3. Start paying GOOD EMI i.e. start a SIP into mutual fund today itself and by increasing the SIP amount as your salary increases, you can enjoy the benefits of the power of compounding, which will help make your dreams into a reality. As they say, “Failing to plan is planning to fail”.
- 4. In case you still prefer to take loans and pay EMIs, then make sure that you are not paying more than 40% of your take home income towards your combined EMIs for various loans.