Don’t use all your Savings for Downpayment & to reduce Home Loan!

This might seem like a no brainer. But I have seen many people cleaning up all their savings to reduce the home loan they are taking.

And that is not right from a risk perspective. It means that (for a lack of better phrase) you are living on the edge. There is another angle to this. Since loan rates are low, will it make sense to give minimum downpayment and invest the surplus elsewhere? But that is another discussion from the investment perspective. I want to talk here about from the risk perspective.

I was recently talking to a friend when this discussion came up. Let me use some broad numbers to help you understand this.

My friend is planning to buy a house for Rs 1.2 crore. So using the 20% downpayment rule, he needs to bring in 20% of Rs 1.2 crore using his own money. That is, he needs to arrange Rs 24 lac from his own pocket for purchasing the house.

Over the last few years, he has saved about Rs 40 lac in fixed deposits, mutual funds, stocks, etc. So he is now contemplating whether to only give 20% downpayment, i.e. Rs 24 lac and take a bigger loan? Or use all the money he has (Rs 40 lac) as the down payment by selling all his investments and reduce the loan borrowing and monthly EMIs?

I cannot deny that having a smaller loan seems like a reasonable approach to take as it lessens the burden. But it comes at a cost if you plan to exhaust all your savings to buy the house. By the way, here is a good approach to decide how much home loan to take?

And people are often too proud of this when they do it – ‘I used all my savings to reduce the loan amount!’ This works well till it does. But in a few cases, where fate has decided something else, this can backfire.

Note – Some people even go to the extent of taking personal loan for downpayment. I would say that this approach is best avoided.

Let’s continue with our example.

For purchase Rs 1.2 Cr house, the bank is willing to give loan for 80%, i.e. Rs 96 lac at 7.5% for a 20-year tenure. The approx. monthly EMI would be Rs 77-78,000 and the total interest paid during the loan tenure will be about Rs 89-90 lac in addition to principal repayment of Rs 96 lac.

Now my friend needs to bring in a minimum 20% as downpayment, i.e. Rs 24 lac. But luckily, he has Rs 40 lac. He is thinking of using the full amount that he has to reduce the loan amount.

So how does the loan maths change (for a 20-year loan) when he uses a higher downpayment amount?

Here are the 2 scenarios:

• Only paying 20% Downpayment = Rs 24 lac. Loan amount: Rs 96 lac. Monthly EMI: Rs 77-78,000. Total interest paid during loan tenure: Rs 89-90 lac.
• Using all money he has (Rs 40 lac), i.e. 33.33% Downpayment = Rs 40 lac. Loan amount: Rs 80 lac. Monthly EMI: Rs 64-65,000. Total interest paid during loan tenure: Rs 74-75 lac.

So in the first case, my friend will have to take Rs 16 lac extra loan, for which the interest amount he would end up paying during normal 20-year tenure would be about Rs 14-15 lac.

To be honest, this looks like a stupid thing to do when you have the money at hand to make a higher downpayment.

But two things here:

• Suppose he uses all his money Rs 40 lac he has. And then bad luck strikes. Job loss, uninsured medical expenses of the family, major repair work back in home town. Anything can go wrong. God forbid. But its possible right? Then how will he manage things as he has already used up all his savings for downpayment? Imagine the mental stress and trauma that he will undergo during this time. And if that’s not all he would have to worry about managing home loan. This is from a risk perspective.
• Then comes from an investment perspective. The additional Rs 16 lac left by not using it for higher downpayment can be invested elsewhere. Let’s say it gets invested in 50:50 Equity:Debt allocation (where equity gives 11% and debt gives 7% average returns). What would be the value of this Rs 16 lac then? Holding on to this Rs 16 lac will create a corpus of Rs 89-90 lac over this period. But we should also consider the savings of about Rs 12,000 per month in EMI too. That too can be considered to be invested for the next 20 years. How does it work out? That too delivers a healthy Rs 80 lac. So on a comparative basis, you earn a bit more if you go for lower downpayment and have extra money left in your hand as well.

But I am of the view that higher priority should be given to the first point about having some savings for emergencies. That is a prudent thing to do even if I ignore the additional return being generated that we discussed in the second point above.

By the way if you didn’t know, you can save several lacs by choosing shorter home loan tenure and paying higher EMIs. In general, smaller the loan you take, better it is. But when buying a house, do not sell everything and use all your savings for the down payment.

Further readings:

• Home Loan rates falling. Should you buy a house now?
• Monthly EMI for Rs 25 lakh home loan
• Monthly EMI for Rs 30 lakh home loan
• Monthly EMI for Rs 50 lakh home loan
• Monthly EMI for Rs 40 lakh home loan 
• Monthly EMI for Rs 1 crore home loan
• Shorter loan tenure saves money in interest paid
• How much home loan can you get?
• Short story of Indian real estate