Home loan – your options now

Over the past few days there have been significant changes in the home loan rates. Though this was being anticipated for quite some time, it was only with the demonetization impact and with a serious nudge from the PM that SBI went ahead and made a huge cut to their MCLR. Other banks followed suit and the effect has been to see the lowest home loan rates for quite a while. SBI and many are at around 8.65 % and I believe Bank of Baroda is the lowest at 8.35 %.

So if you are thinking of taking a home loan now to buy a house, is it a good time? To begin with if you want to stay in it, that is definitely a good idea. In case you are looking at the purchase as an investment, my suggestion will be that you wait to see how the realty market settles down in the next few months. Look at the following for the loan:-

  • Take a loan that you really need and pay as much as you can on your own. Remember even at lower rates of interest you are paying for the loan.
  • Negotiate on the rates as well as the waiver of processing fees.
  • Do not go for loans with a tenure of more than 15 years, 10 would be preferable.
  • Make sure there are no prepayment penalties associated with the loan.
  • Go for a pure floating rate loan, avoid ones that are part fixed for the first few years etc.

What if you are already having an existing loan? Well, that will depend on the context – see below for how you should go about it.

  • If your loan was taken after April 1, 2016 then it is linked to MCLR. In this case, you do not need to do anything, your rates will get adjusted to the new ones.
  • Remember the MCLR reset is done at different frequencies by different banks. Check with your bank to know when the rates will get reset.
  • In case you have an older loan, it is probably linked to BPLR and you need to look at possible switch. There will be a switching fee associated with the change. This is normally between 0.5 % to 1 % of your outstanding loan amount for most banks and is capped at 10000 Rs.
  • Check the EMI difference you are getting and multiply it with the outstanding tenure in months. If this amount is significantly more than the switching fee you should switch your loan.
  • If, for some reason, your bank is not being cooperative look at other options.
  • When you switch, do not reduce the EMI but ask for a reduction in tenure.
  • As a general strategy continue to prepay whenever you can.

As you would know, I dislike any kind of loans and would suggest you avoid them if possible. However, you do need to take a loan for housing in all probability. Make sure that you are discerning while taking the loan, limit the amount by paying as much as you can on your own and prepay aggressively.

Your home should be a great asset to you, not a liability in the form of an outstanding home loan.

Education loan – A personal case study

In the previous post I had outlined a plan that can be used for paying the Graduation expenses of a child through Education loan. Now, whether you are paying these expenses through invested money, current active income or through an Education loan, I am of the opinion that parents are responsible for the graduation expenses for the child. In effect this means, even if you take a loan, you should be paying it back and not the child. Of course, this will differ if the parent is economically weak, in which case it makes sense for the child to take care of the loan repayment once he/she gets a job.

When it comes to post graduation, my thoughts are quite different. I feel that children need to be responsible for their post graduation expenses and fund it through Education loans to be paid back when they start their working life. A second professional degree needs to be funded by the children as the purpose of it is to get a better career, after the first degree has been sponsored by their parents. Note that I am talking of expensive degrees such as an MS or an MBA here, not PG degrees from government universities that are relatively inexpensive even today.

When my daughter Rinki was looking at admissions to a good B school, she and I discussed extensively on these issues in order to figure out an optimal way in which we could do this. I will not go into details, if you are interested look up the posts in the “Education” category of my blog.She had been groomed in a way that she was quite prepared to take the loan on her own and pay it back in a reasonably short time. Her admission in the BM program in XLRI meant the costs would be 21 lacs for the 2 year course. Assuming another 1 lac for travel and personal expenses it meant an outlay of 22 lacs. While I wanted her to be responsible for this amount, I did not see much point in paying a huge amount of interest to the bank. Based on this, the plan we worked out was as follows:-

  • I will loan her the first year expenses and the second year will be funded by the bank. She will first pay off the bank loan to minimize the outgo of interest.
  • Repayment to me could be done later and would depend on factors like whether she wanted to do something on her own ( instead of a job) etc.
  • Based on this we got a 12 lacs loan sanctioned from the SBI branch at XLRI. The plan is to pay the loan in 5 years with the EMI being 25,173.
  • The loan is in her name, with her mother being the co-borrower. There is no collateral needed for the SBI scholar loan.

This plan is in motion now and I have arranged to pay the fees for the first two terms till now. I have also kept money aside for the third term fees that need to be paid in November. Though we have sanction for 12 lacs loan, we may not take the full amount – in case some surplus money is available next year, I may pay off part of the year 2 fees also.

If readers have any queries about the plan or anything about the loan, I will be happy to answer these.

Innovative use of Education loan

As all my readers will know, I am not fond of loans by a long stretch of imagination. In general, I believe that loans should not be used for consumption and, even in a crisis situation, they should really be the last resort. If a loan is needed to acquire a high value asset like a home, my preference is to pay it off as soon as you can. However, there can be some specific situations where an Education loan can be used in an innovative manner.

Before getting into the how and why of it, let us take a look at how we normally plan for the graduation expenses for our children. Typically, this will be done over a period of 15 years or so through some equity instrument such as Mutual funds through regular SIP or other mode of investment. If you have assumed a 12 % return over a reasonably long period it is likely that you will achieve your goal targets. To be on the safe side you may want to follow something like the plan below:-

  • Let us say, your estimate of your child starting his college education is in 2020 and the amount estimated over 4 years from 2020 is 12 lacs.
  • Your SIP corpus has reached a level of 11 lacs now, after the current market run up.
  • You can redeem your corpus in MF, put it into a safer debt fund and be quite certain that you will have the 12 lacs needed in 2020 when it is needed.

While the above is a perfectly acceptable way of doing things, it does have certain basic deficiencies which you may want to look at:-

  • You are redeeming your portfolio 3 years early, to be on the safe side. This may seriously hamper the growth opportunities.
  • You do not need all of 12 lacs in 2020, the requirement is over a 4 year period. It is therefore inefficient use of resources to block it in a low return debt fund etc.
  • As you are not aware of what exactly your child will land up for graduation, your need for money may be more or less than the plan you have made.

One way to look at this issue afresh is to consider Education loans from Public Sector banks. Now, the earlier rates of loans were in the range of 13% and more as it was not perceived to be a safe loan by the banks. At these prices, it does not make sense to take a loan. However, there is a class of loans nowadays, which are restricted to some listed Educational institutions, where the lending rates are way lower. At the present point of time the rates are in the range of 9.5%. With this option being available to you, the plan can be sufficiently tweaked as follows:-

  • Focus on the preparation of your child for competitive exams, so that he is likely to get into one of the listed colleges.
  • If you think it is needed for your child, have a goal amounting to 3 lacs or so when he starts in class 11, for the expenses related to coaching for competitive exams.
  • You may have earmarked an investment for your child’s graduation, but simply let it grow without getting into unproductive mechanisms of redeeming it and then putting the amount in debt instruments etc.
  • At the point of time you get admission for your child, take a sanction for the full expenses through an Education loan from a PSU bank, SBI or otherwise. Make sure it is a loan where there are no pre-payment penalties.
  • As far as payment goes. it will normally be every 6 months or so. As far as possible try to pay it from your active income if you are in a job or profession. If not look at whether it makes sense to redeem your equity investment to the extent of the installment of fees. The final option will be to get the Education loan disbursed for this part.
  • Whenever the market goes up substantially, redeem part of your equity holdings and try to pre-pay part of the loan already disbursed.
  • Over a 7 year period ( 3 years before the course and 4 years of the college), it is very likely that the markets will do well in a few years.
  • In the worst case, just keep holding equity and use the Education loan to the full extent. Start paying the EMI and when the opportunity presents itself, repay as much of the loan as you can.

Of course, there will also be situations where you have not invested adequately for your child’s education. In such cases the Education loan is a boon as it will still enable your child to study in the course and college of his choice. Once he/she passes out the loan can be paid off over a period of time.

I will encourage all of you to look at this strategy. It will ensure that your investments are being used productively and you do not need to redeem them at an inopportune time.

Cars are great, car loans are not

Regular readers of my blog will know that I do not really like loans. The main reason is that it militates against my belief that we should be able to afford any asset that we are buying. A home is an exception as it is a significantly high value asset and most of us are not going to be able to buy a home without a loan. However, even in the case of a home loan I am keen that people pay it back as soon as practicable. It just does not make sense to keep paying the high interests if you have a way out.

Now while I can accept a home loan as something of a necessary evil, I am completely against car loans. The most important reason in my book for not taking a car loan is this – a car is a depreciating asset and therefore funding it through a loan over a period of time just does not make any financial sense. Let me explain it with an example:-

  • Ravi wants to buy a mid size sedan for his family of 4. Though he would be happy with an entry level sedan, the suggestions from his family and friends pushed up his needs to a relatively high end one costing 10.5 lacs on the road.
  • His current hatchback can be sold for 2.5 lacs and he wanted to take a loan of 8 lacs. At 11% rate of interest ( special one ) he has an EMI of 17,394 for a 5 year term.
  • Ravi’s post tax salary is about 1.5 lacs per month and his home loan EMI is 50000 per month. He therefore feels that this EMI is affordable to him.
  • Total interest paid by Ravi over 5 years is nearly 2.5 lacs. More importantly, at the end of 1 year itself he will be lucky to be able to sell the car at 8 lacs or so. In effect Ravi is paying 13 lacs for a car costing 10.5 lacs today, with decreasing asset value.
  • In simple terms, at the high rates of interest in our economy it just does not make sense for us to fund depreciating assets through loan.
  • Again, even if you do so for some very specific reason, pay it back as soon as you can.

Now, understand here that buying a car is normally nor an emergency situation and buying a particular brand or model almost never is. The easy accessibility of loans and higher disposable incomes that we see nowadays may give you a feeling that you can afford to buy it. The reality is you will be far better off if you buy a car you can afford, ideally through paying for it in full. If this amount seems exorbitant to you then you probably cannot afford it. By the time you will pay off the loan, your car is more than 5 years old and may be having some problems now. There are many newer models in the market and your family and friends are probably dropping broad hints that you need to re-look at your car.

How should you buy a car then? Well, I am completely in favour of an all cash deal, especially when you have money in debt products giving you way less returns than the interest on the proposed car loan. It is important you buy a car and model which you like, there is no point in having dissonance immediately after you have bought it. So if you are just starting off in your career today at 24, let me give you a road map.

  • Let your first vehicle be a Bike if you really need one. With the transport options in some cities today, you may afford to be without one for some years.
  • Target to buy your first car at 28 years or so. For this save about 1 lac per year which should be fairly easy. Initial car can be a high end hatchback costing 4-5 lacs.
  • Look at buying a high end sedan in next 6-7 years when your family is probably complete. Again pay with cash after you trade in your hatchback.
  • If you are really fond of cars go for an entry level luxury sedan costing in the range of 16-18 lacs when you are around 45 or so.
  • Finally if you can afford to splurge later in life go in for a luxury car in the range of 40-50 lacs or more. This could well be wishful thinking though.

Of course, a better way can be to not buy a car and get your company to give one to you as part of your compensation. If you are lucky to be in such a position, that is the best deal. If not , follow the mode suggested in the post.

Education loan for my daughter

Now that Rinki has finally got admitted and started in the BM program in XLRI, I thought it will be a good idea to update the readers on the final outcome of it. I hope some of you have read the earlier posts on the considerations of Education loan and how I went about deciding on the same. If you have not read those posts, maybe you want to do so now.

To give the background of the costs involved in XLRI BM program and my thought process in going for the loan, let me outline the basic aspects:-

  • Total cost of the course for payment to XLRI is 21.04 lacs. Assuming some expenses for travel and other personal needs the total requirement will probably be 22 lacs.
  • My understanding with both my children has always been that I would take care of their Graduation costs, irrespective of the expenses and if they wanted to do a Post Graduate education they would be responsible for it. Rinki was always comfortable with this approach and knew that she will be taking up an Educational loan.
  • The XLRI BM program which she got into is the most expensive program of it’s kind in the country and several banks approached her for giving the loan up to 25 lacs.
  • As i was uncomfortable about paying a high amount for interest, I wanted to pay part of this 22 lacs on my own. Rinki could pay it back, based on her situation after she finished squaring off the loan with the bank first.
  • I had to pay the initial 5.42 lacs for confirming the application in April. Apart from this there are 2 other instalments in 2016 that I plan to pay.
  • So I was looking Rinki to take a loan of 12 lacs. The rate was 9.45 % floating based on the MCLR at present.

We had been approached by several banks as soon as she got an offer from XLRI. Though most of them had similar terms, we preferred SBI Scholar loan as Rinki already had an SBI account in her name which she could use. All banks were fine with having any one of the parents as a co-borrower, irrespective of their income levels. We decided to have Lipi as the co-borrower as it involved far less documentation that way. All the documentation needed as per the checklist was collected by us before we left Hyderabad for Jamshedpur.

The loan process itself was very smooth in Jamshedpur XLRI branch of SBI. We were very impressed with the branch manager for the way he and his staff ran the branch as well as his personal accessibility. The process was efficient in checking the required documentation and for people who needed help in filling up the form, people from the bank stepped up quite willingly. Yes, it was business for them but you do not see such levels of service even in many private banks.The branch manager was available to clear any doubt. For example, I was told that we should take the second instalment money from the bank as the sanctioned loan had to be activated within 3 months. I was uncomfortable with that as it would increase the interest burden considerably. When I approached the Branch manager he told me to take a small amount as a loan and pay the rest through our own resources. 

The sanctioning of the loan was done on the same day which was fairly amazing. The repayment duration Rinki has chosen is 5 years. Assuming she takes the entire 12 lacs, the EMI will come to about 26000 Rs. Given the jobs she will be aiming for, this should not pose an issue. In fact, she is keen to pay off the loan early if she can. The overall interest burden is about 3 lacs plus and as there is no pre-payment penalty, paying off the loan amount early will go a long way in reduction of this amount.

As far as the amount paid by me is concerned, I have told Rinki that she can look at it after she finishes her bank loan. In reality, I have a different plan for this but that can be taken up later on when the time comes.

The real truth about asset ownership & loans

Since the time I have started writing this blog, I have interacted with many people who are very proud of the assets that they own. These can be financial assets such as Stocks, Bonds or MF units. These can also be real assets such as a car , a house, Land etc. The one thing which nearly always surprises me is that how many of them do not understand a fundamental point about owning an asset – you really own an asset only when you have paid up in full for it.

Now many of you think that I am nit-picking here. After all even if you have bought a home by taking a hefty loan, the home is in your name, right? You are staying in it and can rent it out tomorrow if you want to. So why do I say that you do not really own it? OK, let us take a simple example to illustrate my point. Let us say you have recently bought an apartment that is priced at 80 lacs. You funded it with your own resources to the extent of 30 lacs and the rest was taken as a loan from the bank. I hope most of you know that the house is now held by the bank as a collateral, till you are able to pay off the entire 50 lacs loan. In fact, should you fail to do so, the bank is well within it’s rights to sell off the house in an auction and claim the 50 lacs plus any due interest from the proceeds of the sale. Obviously, if you really owned the house this will never happen.

So in reality, if you own a house which has a bank loan funding it, what do you own? Well, you do own the house partly, to the tune of the amount of money you have contributed towards the cost. In the above example, you paid 30 lacs out of 80 lacs so you own 37.5 % of the house to begin with. Now as you keep paying your EMI every month, your ownership of the house will keep increasing. Keep in mind though, in the first few years the rate will be slow as much of the EMI amount goes towards the interest component. So if the house price remained constant and your loan tenure was 20 years, you would approximately be adding to your ownership by 3 % every year.

Now, the good thing in our country is that the prices of real estate generally go up over time. Thus when we are looking at house ownership, the right aspect to consider is the worth of your holding rather than your % holding of original price. Let me make this clear by using the same example:-

  • Let us say in 10 years the price of the house has gone up to 1.4 crores.
  • Total amount paid off till 10th year is 60 lacs (say)
  • Outstanding loan to the bank is still 60 lacs ( with interest )
  • So your equity in the house now is 80 lacs. In reality it is more as you can pre-pay.
  • So with an appreciating asset where the rate of appreciation is greater than the interest rate it will in general make sense to get the asset on loan, even though your ownership of the asset is limited.

So is the home loan a “good loan” then as many people say? Not really as you end up paying about 1.2 crores for 50 lac loan and get full ownership of your apartment when it is 20 years old !! Your family may have been pushing you for years by then to get a newer apartment. In reality all loans are avoidable – they are however imperative at times simply as you do not have adequate money to cover for the asset. In such an event, take the loan but pre-pay it as soon as you can.

Now look at a situation such as a car where the asset is a depreciating one. Here it makes very little sense to take a loan as you will probably be still paying your EMI by the time you start thinking of getting a new car. If you assume the life of a car to be 10 years then under no circumstances should you look at a loan tenure of more than 5 years. And if you are the kind of person who wants to change his car every 5 years, then forget about loans and think of buying a car only when you are able to pay it off in full. A direct follow up from this will be this – never take loans for anything whose life is less than 5 years.

Asset ownership makes us feel good but we need to be clear about the affordability of it. For long term assets we can look at our long term earning potential and take a long term loan, with the knowledge that our asset is quite likely to appreciate. However, for assets with short life such as a smartphone, we need to be able to afford it today.If you have to buy it on loan and know that you will need to replace it after 3 years, then you really cannot afford it.

Think about what you just read and look back on some of the last few asset purchases that you did. You cannot change those now but you can make sure that in future you are buying assets that you can truly afford.

PG education for children – Education loan or parental funding?

Let me write today on a topic that I have been thinking about quite a lot lately. Most people will agree that in the era of specialization that we live in, a PG education will add a lot of value to our children. If they have the capability of getting into a good course in a reputed institute, they should definitely do it. The question is how should the course expenses be funded? In essence, there are only two ways of funding it, either the child takes a loan or the parent funds it.

This is of course assuming that the course is a relatively expensive one and the child is doing it directly after his/her graduation. In the first case where the course is in a Government college or in a place where the student gets a stipend for covering the expenses it is a non-issue. In the next case the child may have worked a few years to save some money to take care of the expenses. So in effect what we are really talking about are some specific situations.

Let us understand in what context a PG education can really get expensive. Broadly, they are as follows:-

  • The child is completing graduation and wants to do an MBA from a top Indian B school. This can cost anything up to 24 lacs for a 2 year course today. The IIM s at Ahmedabad, Bangalore and Calcutta are the most expensive. The one year course at ISB is even more expensive but as that requires a fair amount of work experience, people doing that would normally fund themselves.
  • Same as above but the course is either an MS or an MBA from a foreign university, mostly in US, UK or Australia. This can cost anything between 50 lacs to 1.5 crores for 2 years, depending on the country, the university in question and whether the student gets any scholarship or not.

Now, Education loans can pretty much cover most of the costs in India but will not suffice for outside India. It is tough for some parents to take care of graduation expenses itself. In such a situation, an education outside India requires serious and dedicated attention to investment right from the day the child is born or maybe even before. In my opinion it does not make any sense to over leverage yourself and send your child to do a PG from a mediocre university at a great cost. I have seen real life examples of such students coming back to India and struggling to get a half decent job, while their parents are really struggling to pay back the huge loan that they had to take for the foreign education. Of course, there are people in our country who have the ability to send their children abroad for education without having to resort to any loans and they should definitely indulge their children if they want to.

So let us look at the next issue – assuming you need to pay 24 lacs or so for a top MBA course in India, should you fund it yourself or expect your child to take an Education loan ? The loan amount in SBI can be up to 20 lacs without collateral and 30 lacs with collateral if your child has got admitted to a premier institution. The collateral will obviously be provided by the parent but the key question is this – who should pay back the loan, the child or the parent? Most parents would want to do it for their children and I would normally support that, as long as they have the financial bandwidth to do so. If the parents are over leveraging themselves and thereby compromising other financial goals such as retirement. After all what is the point of funding your child for his PG and then expecting him to support you in your retirement?

There are some advantages of letting the child take the responsibility for loan repayment also. To start with it will inculcate a sense of financial judiciousness as EMI has to be paid month on month. Tax benefits are also of great help to the child as she starts earning. At the same time, in the unfortunate event of a job loss there will be a huge amount of pressure on the child in paying back the loan as there will be inevitable default, playing havoc with the credit rating. I have seen these happen to some people who I act as a mentor to, and it is really tough. A better way can be to let the child take the responsibility of the loan payment and step in if he needs support due to any unforeseen mishaps.

When I studied in IIM Calcutta, after my BE in Computer Science from Jadavpur university, the expenses were footed by my parents. In those days education loans were not available so that was really the only viable way of doing the course. Of course there were heavy subsidies from the government for IIM s then and the expenses were not high by the 1980’s standard too but for a middle class family with 3 children that would also have been a stretch.

Now when my daughter sits for CAT and will hopefully get through, I am faced with this tough choice. As a father I want to ensure that my daughter has the best of every possible opportunity. At the same time I want her to grow up as a responsible adult. I can afford the fee so giving her the best part is easy. As far as making her responsible is concerned getting her to take an Education loan will be a great starting lesson in life. On the balance, I think I will take the loan for her and ask her to pay for it based on the kind of job she gets. In the process of making her responsible, I do not want to put a huge amount of unnecessary pressure on her.

While some of us can afford it, there are many parents who cannot do so for their children’s PG or very often even for their graduation. I help out in some forum for students aspiring to join Engineering colleges such as BITS or Manipal and come across many cases where the parents earn less than 5 lacs a year and therefore quite unable to pay out 3 lacs per year for the education of their child. The easily available education loan is really a boon to such students and is a big factor in ensuring that quality education is not denied for want of money.

We criticize our public sector banks so much and so often, but in many ways, as in this, they are the true contributors in the building of our nation.