After you take a home loan

Caution: Do this if and only if your investments are yielding less than the EMI's you are paying out towards your home loan.

In my previous post, I discussed what you should do before you take a home loan.

Now that you have taken that home loan and you are now the proud owner of your grand new home, start thinking of reducing debt. This is by far the biggest debt you are likely to have.

But first, take an account of the money you will be spending on your house from now on:

a) Maintenance - from now on you will be constantly engaged in some enhancement / repair or the other
b) Fresh coat of paint every 4-5 years - you cannot be seen dead in a shabby looking house, now, will you?
c) Yearly Property tax

What you save immediately are:

i) That rent that you were paying to someone else
ii) Income tax
Therefore, the actual EMI you are paying out is only the money you are paying on top of (i) and (ii).

If you are alright with the outflow, do not bother to reduce the debt. You may feel the pinch for the next few years but soon your income will increase (you are due for a promotion, aren't you?) and then the EMI will seem lot smaller (as a % of you total income, I mean).

But if your EMI is HUGE, then try reducing the debt as soon as possible.

Here are three methods that I know of:

a) Some banks offer an account along with the loan (often called a Home Saver Account or something similar). You could park your excess money in that account. The account will earn the same amount of interest as your home loan. You don't get the interest earned in your hand. It goes to the home loan interest. So, it is like paying off a part of the interest but having liquidity at the same time. The best way is to direct your office to pay your salary to this account. Here's an example.

b) Look out from banks that offer a much less interest if you are willing to move your home loan from other banks to this bank. Read the offer carefully though. There may be certain conditions in those fine prints that may not be to your liking. Also switching costs may be high. In any case, what you could do is go to your existing bank and tell them that the other bank is enticing me with a lower EMI, and whether they could do something about it. You have a great chance to reduce your existing EMI.

c) I have done this and works like magic - suppose, you get some extra money from somewhere (could be a bonus from your company). Pay off a part of your home loan. The trick is that you need to do this early on. You see, the initial EMI's have larger component of your principal and lesser component of your interest. Your EMI's that you pay later have substantial interest component. So, paying off even a small amount early on in the tenure goes a longer way in chopping off months from your tenure.

There is one last note I wish to add: If you are on floating interest and the interest drops, the bank will offer you a choice between reduced tenure or reduced EMI. I always chose the reduced tenure. By combining this and paying off parts of the principal early on, I reduced my home loan tenure from 15 years to 6.5 years, at which point I borrowed some money from my parents and paid off the entire home loan. Yes. Today I have a home that is debt free. That leaves me with an asset that can be mortgaged, should I need to.

Before you take a home loan

In my post yesterday, I talked about reducing your debt. This post is focused totally on reducing your debt created by your home loan. Having a roof over your head is a middle-class dream (actually everybody's dream - who wants to shuttle from one house to another every 11 months).

Here are a few aspects that you need to consider before you take a home loan:

1) Do not take loan from the first bank you approaches you. Talk to as many banks as you wish to. And let the banks know that you are talking to many banks.

2) It is not necessary to take loan from the same bank as your friend did.

3) Negotiate, negotiate, negotiate. Every aspect is negotiable.

4) If you tell one bank that the other bank is giving you the loan at a lower Equated Monthly Installments (EMI), the first bank will reduce its EMI to match. (Hint: Ask the first bank to better the offer; not just match.)

5) Floating interest rates are always better than the fixed loans. Remember that the fixed loan is not really fixed for life. If there is a huge upward difference between what was offered and what it is now, banks are within their right to hike your interest rate upwards. They will never reduce it downwards though.

6) Don't bother about interest rate. Instead find out what will be your EMI. There are many EMI calculators available online. Check out your EMI from that calculator and compare with what the banker has to say.

7) Always go for loans where you can make advance payments - in part or in full - without penalty. If all the banks offer pre-closure of loans with penalty, find out the penalty amount. Get this in writing.

8) Your insurance company, such as LIC of India, may also offer loans that also covers your death or disability. This is a good option, if you are already not covered adequately. There is a huge advantage in this. In case of your untimely death - God/Nature forbid - your dependents will no longer have to repay the loan.

9) Most of the time, you will be talking to an agent of the bank. The agent will promise you the earth. The bank may not follow it up. Maintain a note book and note down what each agent has promised you. When the bank gives you the loan letter check if all that was promised is included in the letter.

10) Do not burden yourself with the maximum offered home loan. Take on as less as possible. See Reduce your debt

Do you have some tips that I missed out?
Please leave a comment.

I will cover the "after" part of the home loan in my next post. Till then take care of your investments and your family.

Reduce that debt

Coming from a middle class background, I was always wary of debt. My parents were never in debt. They postponed acquiring luxury items, but never borrowed money to buy that refrigerator and the colour TV (both purchased from a matured insurance). Besides, those days, India had not yet seen the consumer boom. Credit was not easily available.

Then things changed. Banks now call and ask if you need loan at easy (easy?) installments. You could buy anything on credit card and pay only 10% of the outstanding (never mind the HUGE interest you pay). Instant gratification is the name of the game.

But, hold on. Is debt such a bad thing?> I could not have purchased a house or my dream car (not every one dreams of a Ferrari or a BMW; some of us dream of Scorpio too) with borrowing from banks. Besides, many companies have debt ("a healthy debt to equity ratio").

So why it is that I have against debt. And it is not just my background. I don't think so. To be get onto debt if and only if you have an investment that is paying you more than you are paying for the debt.

Let me take an example. For most Indians, buying a house is beyond our means. We need to borrow money from the bank. The house will be yours for Rs. 32,00,000. Let's assume you have the paying capacity to borrow Rs. 22,00,000 @ 9% interest. You could have paid Rs 12,00,000 from your pocket but since bank is ready to pay that much amount, you put in Rs. 10,00,000. My question to you is: what would you do with the Rs. 2,00,000 left with you. Are you keeping it for some contingency? Or are you going to invest it in an instrument which returns you more than 9%? If you are saving it for some unknown contingency, you have not been reading my blog. Get an insurance, man!
If the Rs. 2,00,000 is not yielding you (after tax) more than 9%, you are just wasting that money. You are better off, taking Rs. 20,00,000 from the bank.

Explore other avenues. Do your parents have some money to spare. Perhaps they can lend you some money. They might have a fixed deposit that is paying them at 6.5%. Take that money and pay them at the rate of 7% (they may refuse to take money from you; but you should insist). Does your company offer loans at low interest. Take that. Reduce that debt.

Put it this way: Given a choice I would like to buy that centrally located house or that spanking car from the fruits of my investment. Ideal. Failing that I would reduce my debt as much as possible