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

Dev Ashish

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:

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:

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:

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