“Hello Subra I have a home loan of Rs. 39 lakhs and I have about Rs. 5 lakhs in my savings bank account – thanks to a bonus and some share sale. Should I invest the Rs. 5 lakhs or should I part repay the home loan?”

I have answered this question a million times and have never been happy with the answer! Why does this happen? Well here is the story.

A person borrows money to buy a house (assuming it is the first house in which he/she is planning to live for say the next 20 years) because he does not have the cash that is necessary to buy a house. For example if the down payment for the house is Rs. 75 lakhs for immediate possession, he may personally have only about Rs. 15 lakhs – and the balance is funded by a loan. Logically the loan is for Rs. 60 lakhs. Now if the buyer had Rs. 30 lakhs, he would have borrowed only Rs. 45 lakhs.

If this is the logic the excess cash in the savings account should be used to repay the housing loan, is it not?

Sadly, the view is divided. For a person with a Rs. 50 lakhs CTC, a good job and a nice net-worth over and above this house, my answer would be, let the loan continue, continue paying the EMI and invest this Rs. 5 lakhs as an one time investment in an equity fund.

However for a person with a Rs. 7 lakhs CTC, not a great qualification and in a job which is not too great, my advice would be ‘Just get rid of the loan as soon as possible, so pay off Rs. 5 lakhs from the loan’.

Also the answer could be different on the basis of the time period that one is looking at. If it is a 2-3 year view, you might be better off down paying the loan, but if it is a 15 year loan, you might be better off paying the EMI and putting this Rs. 5 lakhs in to an equity fund.

When a person takes a Rs. 75 lakhs as a loan – his dad or mom would have quipped ‘I took only Rs. 1.5 lakhs as a loan in 1977 to buy a house’ – you guys are borrowing so much! Actually the way to look at a loan is to look at it as ‘X times ctc’. So if your dad had a Rs. 25,000 ctc – he was taking 6 years ctc as a loan. If you have a Rs. 30 L ctc you are taking a 2.5 X ctc as a loan! So if you are a person who is scared of the sheer size of the loan, down pay a little, if you can think as ctc X 3, continue your loan.

If you can think of increase in net-worth is the ultimate aim of working, invest Rs. 5 lakhs. If you think down paying of loan is the most important reason for earning money, repay your loan.

Let us take this case of Khyati:

Current Loan balance : Rs. 39,00,000
Current mortgage rate 14.5% (and rising?)
Years left on mortgage: 13
Years until retirement (at 55, hopefully!): 19, good rising salary expected until then
Current place the money is parked: savings account earning about 3% p.a.
Any other big commitment: No, none. Will stay in the same house.
Other retirement savings: PPF, PF, some direct equity and some sundry mutual funds.
House value: approximately Rs. 1,25,00,000 in a Mumbai suburb
Other debt: just monthly credit cards that are paid in full, no car payments, no personal  loans, etc.
Children’s education well provided for already
Return on mutual fund investments, equity shares etc. – never computed correctly so not a factor while considering the options.

By repaying this loan Khyati will clearly generate 14.5% p.a. return – which is really difficult for her otherwise. Khyati  typically does a few SIPs, has some direct equity, and has some small amount lying in various other investments. Since the whole thing is not well documented, it is almost impossible to know what returns she is getting on her overall weighted portfolio.

Also this advice of ‘pay off all the loan’ would have been brilliant in the year 2007 (November or December), but put it in equity would have been brilliant in 2009 January! Do a SIP would have been still a good advice starting Jan 2009…

So even though keeping the loan or investing the money is a mathematical and financial decision, it has to be taken with a lot of emotion. The psychological impact of saying “I am leading a mortgage free life” is very important for many people. However I do know of friends with a net-worth of Rs. 10 crores who will also have a debt of Rs. 2-3 crores.

Largely if you are leveraging with a view of creating a real estate portfolio, you know when to buy, when to rent, when to sell, which location to buy, know how to buy a distress sale property, etc. go ahead and experiment. However if you are not clear about all these things, you are not planning to buy and sell shares, you are not here to create a portfolio, etc. just take that Rs. 5 lakhs and part repay the home loan.

Personally,  I told Khyati, ‘I am convinced that the equity markets may go nowhere in the next 3 quarters…but if you are asking me what will happen in the next 30 quarters, I think it will give returns in excess of your home loan interest rates. So clearly if it is a longer time frame that you are looking at, put that Rs. 5 lakhs in an equity fund – perhaps as a SIP over 6 months. Withdraw from your PPF, PF and en-cash your national savings certificates, and repay all the borrowings – all of them yield less than your cost of borrowing in India.

However if you have a 2-3 year view it may be worthwhile to reduce your debt, because getting 14% returns on equity over the next 2-3 years looks tough. I hope I am proved wrong.

"CA P V Subramanyam is a Trainer and runs www.subramoney.com "

e-mail: PV Subramanyam

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