Indian one hundred rupee banknotes are held for an arranged photograph. (Photographer: Prashanth Vishwanathan/Bloomberg)

The Mutual Fund Show: This Strategy Not Only Helps You To Prepay A Home Loan But Also Create Wealth

Would you want to prepay your home loan given the rate of interest is less than 9 percent and equities are outperforming?

Or you think it’s more rational to invest systematically in mutual funds and enjoy higher returns?

Independent financial advisor Vijai Mantri rules out the second option. “There are a couple of reasons for this,” Mantri said on BloombergQuint’s weekly series The Mutual Fund Show. First, he said, equity investors repent their decision to not withdraw money at elevated market levels while they are still repaying the loan. Second, a common complaint about lack of profit- or loss-booking advice by financial advisors.

Mantri, however, has devised a four-step strategy to help investors prepay their housing loan as well as accumulate wealth over time.

  1. Invest one-third of the monthly housing loan installment in the NSE Nifty 50 Index every month and do not withdraw the amount for the first three years.
  2. Evaluate the portfolio after three years. If the return exceeds 15 percent on a compounded basis, withdraw all the amount that has been accumulated over the first two years. Use the proceeds to partly prepay the outstanding home loan.
  3. Repeat the above steps and evaluate the portfolio after every two years, hereon.
  4. After the loan is repaid, convert the monthly installment, along with the original investment, into a monthly systematic investment in mutual funds.

(The Nifty Index is being used for illustration purpose only)

Watch the complete episode where Mantri shows that how a 20-year housing loan can be repaid in less than 11 years using this strategy.

Here are edited transcripts from the conversation:

If you have a home loan, using mutual funds, you can negate the cost-plus interest, over the period of 20 years. Now, you have come up with strategy of pre-paying the loan. If home loans are so cheap, why will somebody want to prepay the home loan? Wouldn’t it be beneficial to have a home loan running and still invest in funds? Do you believe that this strategy will generate wealth?

Vijai Mantri: I agree that home loans are currently below 9 percent. Equities tend to deliver much better return than housing loan interest. But investing is not about numbers. We have seen many investors worrying about the home loan they have on the books and at the same time they are investing. So, when the market goes down, they say if only had I could taken money out when the market was rising, and partly paid my housing loan. We, as Indians, don’t like to keep housing loan. We think to repay it soon which will be much better. This is one part.

The second part is that, there are a lot of complaints that financial advisors keep talking about investing for the long term, invest in SIP and continue for the long term but you don’t tell when to take the money out. So, this strategy combines both these things and helps investor not only to prepay the housing loan but create an opportunity to create huge wealth for investors for a long period of time.

Imagine you had a home loan amount of Rs 60 lakh in 1990 with a duration of 20 years or 240 months and the interest that you pay will go up to Rs 84 lakh and the total amount payable is Rs 1.44 crore. How have you arrived at these numbers?

Mantri: I have taken last 20 years’ average home loan rate which is close to 10.5 percent. Currently, home loan interest is 8.6-9 percent. But I have taken 20 years’ historical numbers because I have also taken 20 years’ market return. So, it is fair that I take the same data from a historical perspective.

For Rs 60 lakh housing loan, you pay close to Rs 60,000 EMI (equated monthly installment) per month and over a 20-year period you pay Rs 84 lakh interest. So, you took Rs 60 lakh housing loan but through EMI you are paying Rs 60,000 per month. So, over a 20-year period, you pay Rs 60 lakh plus Rs 84 lakh, which is Rs 1.44 crore you will pay to the housing finance company.

So, what is the strategy for pre-paying the home loan?

Mantri: You have Rs 60,000 EMI. So, start Rs 20,000 SIP. For the sake of avoiding any complications, I have taken Nifty, but you can take any other scheme. So, you have started Rs 20,000 SIP in Nifty. You are paying Rs 60,000 EMI and you have also started Rs 20,000 SIP. Don’t touch this for the first three years—continue to pay Rs 60,000 as EMI and Rs 20,000 SIP for the first three years.

After 3 years, you look at how your SIP has done. If you have set the return target of 12-18 percent CAGR on the entire portfolio. So, 36 months IRR (internal rate of return) of the SIP. For the sake of convenience, I have taken 15 percent. You set 15 percent target rate on SIP. After three years, if the IRR of SIP goes beyond 15 percent, then it means markets are doing very well and it is rising.

You take all your money out, except the last 12 months’. Don’t touch the amount for the last 12 months because there could be exit load and tax complications.

So, suppose you are doing review of 48 months, then you take out money from 1-36 months. Take that money out because you have hit the 15 percent target. It is not necessary that you have 15 percent target in 36 months. Sometimes, it takes 48-60 months. Whenever you hit the 15 percent, the target you have in mind, you take out that money except the last 12 installments of SIP and to that extent you pre-pay your housing loan. Lot of customers believe that advisors don’t tell when to take the money out. So, this is a simple strategy.

It helps you to sell in the rising market. While selling in the rising market, you are also paying your liability. So, you get a lot of mental comfort that I am knocking off my liability.

If the 15 percent return happens in the 43rd month then you remove the money invested in the first 31 months and repay that money?

Mantri: Yes and you continue with your SIP. You are not stopping your SIP.

So, what is next step?

Mantri: Evaluate your investment after every two years. Whenever you had this situation and hit the 15 percent level, you take the money out. After two years if the returns have not exceeded 15 percent then continue to do SIP. Review every quarter on that basis.

So, investors may have to do this exercise twice or thrice or maybe even four times. It depends on when the investor first hits 15 percent IRR.

Mantri: On an average, it will happen twice or thrice.

On an average, you will be able to repay your 20-year housing loan in 10-11 years. 

So, the market goes through the bull cycle of every 8-10 years. So, when you hit 15 percent, the next 15 percent will come in the fag-end. So, maximum you end up doing this exercise twice but it will have huge benefits.

So, what is step 4?

Mantri: Once you repay the housing loan of 20 years in 15 years, after that there is no EMI. So, Rs 60,000 EMI then gets converted into SIP and your Rs 20,000 SIP continues. So, you have an SIP of Rs 80,000. There is huge advantage of this structure because you have trusted SIP to prepay the housing loan. So, as the housing loan is repaid, let the EMI get converted into SIP. Normal investor who have paid the housing loan in other ways don’t have that kind of trust in SIP. As your SIP is not Rs 20,000 but Rs 80,000, so through the period of time, it will create more wealth for you.

Does it give any idea of how an average investor is able to repay his 20-year housing loan, if he has followed this strategy?

Mantri: It is incredible. We have just taken top line Nifty number without considering dividend yield of Nifty which has been close to 1.4 percent per annum for last 20 years. But you just take top line Nifty number and you followed this strategy, then a 20-year housing loan on an average gets repaid around less than 11 years in Nifty. So, 240-month housing loan got repaid in just 130 months on an average. There has been a period when the market was rising and at that time the housing loan has been repaid in less than 10 years. On an average since 1990, the housing loan got repaid in 130 months.

The last observation was made in May 2007. Suppose you have taken a housing loan in May 2007 and followed this strategy, so by this time, your housing loan got completely repaid in almost 11 years.

If I have taken a loan of Rs 60 lakh and on that loan my interest was Rs 84 lakh. So, there is a lot of money I have invested as an interest on loan. If we have taken this strategy, what could have been the reduction in interest payable?

Mantri: Potentially, you could have paid Rs 84 lakh of interest, but through this strategy you are paying only Rs 46 lakh and you are saving Rs 38 lakh. Which, in my opinion, is 80 percent of what you actually paid. You have to see from the perspective of how much you have to pay, this is 60 percent and you are saving 40 percent of potential interest outflow through this strategy.

Let’s take the example of an investor who started this exercise in 1990. He finished his home loan in 11 years; that is, he finished the investments of Rs 80,000 per month by 2010. Then if he continues to invest the money in mutual funds, how much is he earning?

Mantri: If you look at the total investment you made through this strategy which tells you that the total EMI which got converted into SIP+SIP minus whatever you have paid through housing loan. So, you have invested Rs 63.8 lakh and the value of the strategy is Rs 1.9 crore. So, you have repaid your housing loan but at the same time you have also created wealth for yourself which if you see that total value of the housing loan that you have repaid is Rs 1.44 crore. But in spite of paying Rs 1.44 crore of loan serving, you today have Rs 1.9 crore as wealth on date.

Which means that the return through this strategy is better than a normal SIP?

Mantri: Exactly. If you look at IRR of this strategy, this outperforms a normal SIP by close to 2 percent. SIP return in any case are staggering. But through this strategy, the normal SIP return are close to 2 percent. I am telling this without considering the dividend yield of the Nifty or else the returns could look much better.

No matter what investment route you choose, if you have a long-term vision in mind of investing in mutual fund scheme, you can repay home loan without fearing what if my fund would underperform.

Mantri: The bigger thing is what will happen if market goes down tomorrow. So, suppose you follow this strategy, perhaps in the beginning of the year, you could have repaid part of the housing loan. So, you don’t have to go through trauma of what happened in the last 3-4 months on your portfolio. The riskier the fund, the better the strategy works because you are taking the money out. Suppose you have followed this strategy in mid- and small-cap funds, then the results could have been much more staggering.