Home Loan Tax Benefits – How much do You Really get?

In India, home loans come with tax benefits. You already know that.

And there is no denying that these tax benefits make it all the more attractive to buy property using home loans.

But time and again I have seen people overestimating these tax benefits. Why?

Because the tax benefits available on home loans are capped. So depending on the home loan they take, the actual benefit may not be as large as what many borrowers think.

Now there are 2 components of a home loan – principal and interest. And the home loan EMI also has the same two components – (i) principal repayment, and (ii) interest payment.

So what tax benefits are available for Home Loan borrowers that can reduce their tax outgo?

  • Deduction of up to Rs 1.5 lac for principal repayment under Section 80C of the Income Tax Act.
  • Deduction of up to Rs 2 lac for interest payment for self-occupied property under Section 24 of the Income Tax Act. The interest payment of up to Rs 2 lac is available as loss under income from a let out property
  • Additional deduction of Rs 50,000 on interest payment, over and above the deduction claimed in Section 24 is available for the first time home buyers under Section 80EE.

Tax Benefits on Home Loan Principal Repayment

A deduction of up to Rs 1.5 lac is available for principal repayment of home loans under Section 80C of the Income Tax Act.

There are few things to note here.

First, Section 80C’s tax savings are also applicable on your investments in EPF, PPF, ELSS (Equity Linked Savings Scheme) and expenses like insurance premiums, school fee, etc.

So all these investments and expenses compete with home loan principal repayment for the Section 80C benefits. Chances are high that the sum of EPF + PPF + ELSS + insurance premiums + Home Loan Principal repaid will be higher than Rs 1.5 lac. If that’s the case, the cap of Rs 1.5 lac in Section 80C limits the benefit to just Rs 1.5 lac irrespective of what you claim from within EPF, PPF, ELSS, premiums or home loan principal repayments.

Even if you have a big loan and are repaying more than Rs 1.5 lac of home loan principal, the tax benefit is limited to just Rs 1.5 lac.

Tax Benefits on Home Loan Interest Payment

Deduction of up to Rs 2 lac is available for interest payment for self-occupied property under Section 24 of the Income Tax Act. And the interest payment of up to Rs 2 lac is available as a loss under income from a let out property.

This is where things get interesting and people get confused.

Due to the above-mentioned capping of benefit, even if you are paying more than Rs 2 lac interest in a given financial year, the excess interest above Rs 2 lac will not fetch you any tax benefits.

Here is a small example:

Suppose you take a Rs 35 lac home loan for 20 years at 9.5%. You EMI will be Rs 32,625 per month (read more about how home loan tenure impacts interest paid).

Home Loan Tax benefit Section 24

As you can see, in total Rs 3.91 lac is paid in EMIs in 1st year. Out of this, principal forms only Rs 61,633 whereas interest is Rs 3.29 lac. Out of this Rs 3.29 lac, only Rs 2 lac is eligible for tax benefits under Section 24. The remaining amount (can be seen in red-colored text) cannot get tax benefits.

The home loans are structured like this that during initial years, a major part of your EMI goes towards interest payment. So it’s possible that the interest you pay in the initial years will be much higher than Rs 2 lac (the limit for tax benefit).

Let’s take another example to find out another interesting aspect.

We compare two loans. First of Rs 25 lac and the second of Rs 50 lac. The loan tenure and interest rate on both are 20 years and 9.5% respectively. The EMIs are Rs 23,303 (for Rs 25 lac home loan) and Rs 46,607 (for Rs 50 lac home loan).

Now have a look at the table below:

Home Loan Tax benefit comparison Section 80 Section 24

For the Rs 25 lac loan, the interest part that misses out on tax benefit is very small (Rs 35,616 in the first year and goes on reducing). But for the Rs 50 lac loan, you initially pay Rs 4.71 lac as interest in the first year. This is much more than the Rs 2 lac per year limit. So you only get the tax benefit on Rs 2 lac of interest (under Section 24). The remaining Rs 2.71 lac doesn’t get any tax benefit.

And if you focus on the table (on right) of Rs 50 lac loan, you will see that you keep having an interest component that misses out on tax benefits till the 15th year. And more interestingly, during the first 7 years of loan repayment, the tax benefit on interest payment of Rs 25 lac loan is the same as tax benefit on Rs 50 lac loan!

So much so and hue and cry for home loan tax benefits. 🙂

This is all the more reason why one needs to look at the tax angle when planning to prepay home loans. And if that wasn’t enough, there is also the dilemma of whether to invest vs prepay home loan – to benefit from higher returns elsewhere as compared to low post-tax home loan interest rates that are prevalent in India.

But I suggest that before you decide to prepay your home loan, you run your own numbers or get in touch with an investment advisor to help you out.

And if you are one among those who are still deciding whether to take a home loan or not, then I suggest that even before you begin your search for home loans online, some time should be spent to understand how home loans actually work and how best you can manage home loans once you take them.

The idea of doing this post was to highlight that at times, people get over excited when it comes to tax benefits from their home loans.

It is quite possible that you may not even get as much tax benefit as you thought you would be getting from your home loan.

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Mutual Funds Vs Real Estate – Which is better for Investing in India?

Real Estate or Mutual Funds? This might be one of the most controversial debates I am starting on Stable Investor. But I had to write about it someday. And by the number of mails I receive from readers asking me to answer this question, it seems that there is much more than just financial logic behind this question. Peer pressure, family pressure and just getting done with this big decision in life are some, which I can think of right now.

Note – This post is a combined effort by Ajay (who has previously authored interesting posts like how to invest your surplus money and how he created a corpus of Rs 3.7 Crores in just 10 years) and myself.

But if you expect us to give you a clear answer at the end of this post, then please tone down your expectations. We do not intend to provide a thumb rule or even a judgment for that matter.

This question of whether you should invest in Real Estate (for investment) or Mutual Funds, can only be answered by you and you alone. This article should ideally be read in that spirit.

Property Vs Mutual Funds

So lets go ahead…

In words of Ajay, a home is a place to live and it should not be linked to one’s investment strategy. There should not be any second thought given about buying your 1st property for self-occupancy whether with or without tax benefits.

My take on this question is not as strong as that of Ajay. But I do agree with him about the power of equities in the long run. As far as my real estate is concerned, I am still weighing my options and am yet to finalize my long-term real estate strategy. As of today, I don’t own any personal property but my family does have a house in our native city.

So why am I delaying this decision unlike many of my friends who are already paying hefty EMIs every month?

I know it might sound odd to those who believe that one should invest in property starting with the very first salary they get. But I am sorry… I don’t belong to that school of thought. I have full faith in power of compounding and investing in equities. And I will only buy my first piece of real estate when I am comfortable enough to service my EMIs. I don’t want to have myself stuck in years of paying EMIs where I feel burdened at the end of every month. I don’t want to be slave of my EMIs.

But that was about me and my philosophy…. 🙂 So you can ignore it…

And for those who think that instead of paying rent, its better to pay EMIs – I have an answer. Paying rent might seem like an expense. But EMI also has a significant component of interest, which even in accounting term is nothing, but Expense. So this argument does not stand completely true.

Once again I repeat that the objective of this article is to highlight the differences in returns earned by investing in mutual funds and those earned by investing in a home funded through a loan, in the name of investment and tax-saving.

We have tried comparing two cases:

One where investment is made in real estate and other where it is made in mutual funds.

So here it is…

Case 1: Real Estate Investment

Following is the data being used:

Value of Property = Rs 75 Lacs (1500 sq ft @ Rs 5000/sq ft)

Required Initial Down Payment (@20% of Property value) = Rs 15 Lacs

Loan Availed (for remaining 80%) = Rs 60 Lacs

Loan Tenure = 20 Years

Loan Interest Rate = 10.15%

Few more administrative costs are as follows:

Loan Processing Charges & Other Expenses (@2% of Property) = Rs 1.5 Lacs

Registration Fees (@10%) = Rs 7.5 Lacs

 

After doing some calculations which are depicted below, we arrived at quite interesting numbers.

India Real Estate Investing Analysis
Interest Paid over 20 Years = Rs 80.30 Lacs

And as you can see in the last column in table above, this property has also been able to generate post-tax and expense adjusted rental income. We used a few assumptions for rental income and expense which are as follows:

  • Rentals increase by 5% every year
  • Rental income from property is taxed at 20%
  • Maintenance expenses are recurring every 5 years: Rs 1 Lac (5th year), Rs 1.5 Lac (10th year), Rs 2 Lacs (15th year) and Rs 2 Lacs (20thyear)

All in all, these result in an amount of Rs 24.67 Lacs being generated from the property over a period of 20 years.

This means, that effectively the property costs about Rs 1.39 Crores as depicted in table below:

India Real Estate Profit 2015

Now as per general perception (at somewhat backed by data too), the properties are known to appreciate in price. But here, we are not talking about property prices doubling every 2-3 years. We are talking about much sensible returns ranging from 9% to 12%.

Lets see what this part of the calculation leads us to:

We will evaluate 3 scenarios where property appreciation is taken as 9%, 10% and 12% continuously for 20 years. And this evaluation is depicted in table below:

India Real Estate Investing
To summarize the above calculations, this property initially cost Rs 75 Lacs. But since loan was taken and it also generated rental income, the total landed cost was Rs 1.39 Crores.

Now when 3 different scenarios are considered where this property appreciates by 12%, 10% and 9%, the expected net gains are Rs 5.1 Cr, Rs 3.4 Cr and Rs 2.75 Cr respectively.

Agreed that these are some really big numbers.

But before you start putting your hands on your mouth after reading them, lets check out the second case where we evaluate similar investments in mutual funds.

Case 2: Mutual Fund Investment

We are using the following data for this case:

Initial lumpsum investment in MF schemes of Rs 24 Lacs. This amount is equal to the sum of Initial Property Down Payment (Rs 15 Lacs), Registration Charges (Rs 7.5 Lacs) and Loan Processing fees (Rs 1.5 Lacs).

Now the EMI amount in earlier case was Rs 58,459. This amount in this case can be used as monthly SIP. But we also need to consider the tax benefit of Rs 1 Lac availed on house loan investment – which is to be equated monthly. That amounts to Rs 8333 and resultant amount available for monthly SIP is Rs 50,126.

So here is the calculation sheet for two types of investment scenarios.

First one is where returns from MF move from initial 12% to 7% in later years. These are conservative numbers when compared to returns given by really good MFs.

Conservative Mutual Fund Investor

Second one is a slightly aggressive returns assumption based analysis. Here the returns move from 15% initially to 7% in later years. But even then the returns of 15% are not that rare and have been achieved by quite a few funds in India for decades.

Aggressive Mutual Fund Investor

Now what happens when these funds are sold after 20 years? There wont be any tax as long term capital gains is not taxed in India for stock market returns.

So for an investment of Rs 1.44 Crores (lump sum + SIP of 20 years), a corpus of Rs 10.28 Crs and Rs 7.06 Crs has been achieved. And mind you, this return has been achieved despite having paid the additional tax @ 8333/- per month for 20 years. And these numbers are substantially higher than the real estate investment even after tax saving.

This means a net expected gain ranging from Rs 5.61 Crs to Rs 8.84 Crs.

Compare these numbers with those of Real Estate case and you will understand what this article is trying to point you towards.

Why do People Invest in Real Estate?

We have tried to list down a few reasons which we though people have for investing in real estate. And here were are not talking about the 1st House but about the 2nd property, which is treated as an investment:

  1. There is mental comfort in buying a hard asset that you can see and feel (also applicable to gold).
  2. It is an asset that can be funded largely through long-term debt (75% Funded by banks). No other asset provides such a benefit.
  3. It is a big asset, which you can acquire and then comfortably pay back via monthly payments (EMIs) over a very long period of time. Once again, no other asset provides this benefit.
  4. The comfort we get by doing mental accounting about tax savings in real estate investments. One always feels happier when one is told that they don’t need to pay tax or no money would be deducted from salary, because of tax savings due to loan-funded real estate investment.
  5. Second income from spouse, which can be used to get additional tax benefits (by being a 1sthome loan for the spouse) by taking a home loan.
  6. Comfort of getting a stream of rental income. An income, which you get without working for – passive income. But most of the times, people forget about the linked expenses.
  7. General opinion that it is a hedge against inflation.
  8. Mental fix that there is Zero Risk in real estate purchases (in reality, there are more risk than most other investments like gold and mutual funds).
  9. Justification that it is an investment for the next generation(s).
  10. High return expectations due to the recent past records (say last 15 Years).
  11. Black money at work!!
  12. Pride of owning multiple real estate investment and being known as the ‘Landlord’.
  13. As there is no daily ticker, the daily mental valuation of the asset does not take place.
  14. Mental satisfaction and happiness when disclosing to others that you own multiple properties.
  15. The perception that since everyone is investing in real estate and profiting from it, even I should do the same and make easy money.
  16. You always hear story from neighbors that they bought a flat for Rs 900 / sq ft 15 years ago and now it is worth Rs 5000 / sq ft. Here mental maths comes into picture. Mentally you might think that this 900 to 5000 appreciation is more than 5 times and a very profitable one. But neighbors comfortably forget to tell you about the expenses they incurred in these 15 years or in repaying loans. Actual returns are always calculated net of expenses. Its neighbor’s envy and owner’s pride (copied from an old Onida TV advertisement). For those who want to turn Rs 900 to Rs 5000 in 15 years, it’s not that tough. You can do it at 12.1% per year.

Why Don’t People Invest in Mutual Funds?

Since you are reading Stable Investor, chances are high that you would be a mutual fund investor. But there are many who avoid mutual funds to invest in real estate. Lets see what are the possible reasons for them to do so:

  1. Lack of knowledge about mutual funds and equity markets.
  2. Lack of understanding about the power of compounding, the power of equity as an asset class and clear knowledge of wealth building via SIP.
  3. Lack of knowledge about asset allocation.
  4. Risk and loss aversion.
  5. Unable to determine financial goals and estimate the amount required.
  6. They have already utilized all the tax benefits available to them because of home loan. Now they have no tax-incentive to invest in mutual funds. And hence they don’t do it!
  7. Bad past experiences. And these are primarily due to wrong fund selection or wrong time horizon or wrong advice (like combining insurance and investment or wrong thinking that saving and investing are same).
  8. As daily price movement of MF through NAVs is available, the daily mental valuation of the asset, forces one to take frequent buy and sell related decisions. This is driven by general lack of patience in investors.
  9. Mutual Funds cannot be funded through Black Money.
  10. Unlike real estate, no long-term loans are available for investments in mutual funds.
  11. More people talk about losses made by investing in funds (for whatever reasons) and very few people talk about their success in meeting financial goals through funds.
  12. Mental fixation with recent huge loss events (like 2000, 2009, 2013 etc.)
  13. A major chunk of saved money has already gone into real estate, which leaves almost no money to invest in mutual funds.
  14. And as substantial money is not invested regularly in mutual funds, one does not feel that substantial money can be made through mutual funds.
  15. You don’t get to hear every day that a fund having a NAV of Rs 28 has grown after 15 years to Rs 805 – a return of 25% per year (Check Reliance Growth Fund). Such returns are very high ones and rare and cannot be matched by real estate investment or investments in other asset classes.

Now lets test your memory…

Do you remember how much did petrol cost in the year 2000?

It was around Rs 25. As of today, it is about Rs 66. Now suppose you had invested that Rs 25 in real estate, which grew at 12.1% as mentioned few paragraphs earlier. This would have grown to Rs 139. Enough to buy 2 liters of petrol today. Now if this was invested in a mutual fund, which somehow could manage 25% return, it would have grown to Rs 711. Enough to buy at least 11 liters of petrol.

That is how equities work. That is how compounding works. That is how value of your money is preserved and increased by investing in right asset class for long periods of time.

Concluding Thoughts

And this is a repetition of earlier statement. One should not give any second thought about buying your 1st property for self-occupancy, whether it is with or without tax benefits.

However, based on our comparative analysis above (and estimated returns), one should think twice (or even ten times…) before buying a second home for investment purpose. One should carefully weigh all the available data and then take a wise call. Just because your friend or family member is investing in real estate does not mean that you should also do it. You should evaluate your own financial goals and think about how you plan to achieve it, and then decide whether you want to ‘invest’ in real estate or not.

A hard and physical asset will always give a huge mental comfort and satisfaction over other financial assets like mutual funds. But it is also true that it may not always be the best available investment option. In fact, investing in house funded through loan, is a huge long-term liability – which chokes the ability of the person to save and invest in other right instruments for future.

In our opinion (and it is ours and you can ignore it), after purchase of the 1st property for self-use, if there is any surplus cash left to invest, you should invest it as per your asset allocation (which includes debt, equity, gold & real estate). If the asset allocation permits you to invest in real estate, you may very well do it. But if it doesn’t, then you should refrain from investing in it. Investing in real estate for the sake of saving tax may not be the best thing to do.

As stated at the beginning of this article, this is one hell of a controversial debate. And there is not straight-forward logical answer to it. There are no thumb rules or any other rules. The question of Real Estate Vs Mutual Funds can only be answered by you an you alone.

We have simply made an attempt to clear the myth that “Real estate investing is the only best Investment Option” available for everyone. We have done all the calculations by estimating the returns net off expenses. We cannot just ignore expenses like those who just tell you the number of times their property has appreciated in value.

Please note that this post may be biased towards Mutual Funds investments.

Do let us know about your thoughts on Real Estate vs. Mutual Fund debate.

Disclaimer:

Returns mentioned in this post are only assumptions and not guaranteed ones (for both Mutual Funds and Real Estate). While there is investment return record available for mutual funds, we could not get a credible investment return data for real state (we took NHB data as guideline). Moreover, the real estate returns vary vastly from location to location.

What I told a Frustrated Guy in Job. At 37, He Retired few Months Back – Part 3

This post was long due after I did Part 1 and 2 in April this year. Though the story of this guy was covered in first two parts, I wanted to do a follow up post highlighting some of the important points raised in comments of the post.

Readers like Krish, Bharat and many others made some noteworthy points, which I feel need to be shared with a larger audience and hence this post.

You can either read the complete story in detail in Parts 1and 2;Or just go through the broad outlines below:

This person had a big home loan, was earning decently, but just sufficient to make ends meet (after paying his monthly loan EMIs), had very little savings and investments and more importantly, was frustrated with his job and financial situation.

Luckily, he inherited a plot of land which till a few months back, he did not know what to do with. 

What he does afterwards, is what changes his life:

Step 1: Sold off the land plot for Rs 9 Crores (post tax).

Step 2: Closed his home loan of Rs 70 Lacs.

Step 3: Created an Emergency Fund of Rs 30 Lacs (which covered his family’s expenses for next 2 years).

Step 4: Put Rs 4 Crores in Fixed Deposits, which provide approximately Rs 1.75 Lacs every month in interests (post tax).

Step 5: Bought 7 flats for Rs 3 Crores

Step 6: Bought a small warehouse (godown) for Rs 1.1 Crore

Step 7: Put 5 (now 6) of these flats on rent for a total of Rs 1 Lac a month.

Step 8: Put Godown on rent of Rs 60,000 a month.

Step 9: Quit his day job

Note – Actually he quit his job before the godown went on rent.

To summarize, he used proceeds of selling his inheritance to create a monthly income stream of more than Rs 3 Lacs. His average monthly expenses are between Rs 50K to 60K.



Now this is the current situation. And we do not know what might happen in future.

But few readers raised concerns about this approach and shared some different approaches. I share their concerns and ideas below:

Point 1: Cashflow is great in terms of interests, rents etc., but over the years expenses also rise. Not only because of inflation, but also because of altogether new expenses like kid’s education, medical bills, renovations, etc.

Point 2: If investment in properties (flats) is made for capital appreciation, then one should understand that it is not that easy to sell off properties. Banks are generally skeptical about lending to buyers for older properties.

Point 3: Once again if investment in property is made for capital appreciation, it makes sense to buy in relatively undeveloped areas. Then wait for 3-5 years and sell them off. In this way, one can cash out on overall upgradation (read: development) of that area, and the increase in desirability quotient of that area. If one waits for more than 5-7 years, there’ll always be a problem of “Old Flat” perception.

Point 4: In rental properties, each time a tenant vacates, it requires big expenses in form of painting, cleaning, plumbing, unsolicited breakdown of utilities, etc to get the flat ready for next occupant. This eventually reduces the actual rental income coming from the property.

Point 5: Dependency on rental income often proves to be fickle and it does not even beat inflation. Since chances of real estate markets being in bubble currently are high, expectations of very high capital appreciation would be wrong.

Point 6: There is an increase in people seeking help / donations / loans when they realize that you are flush with funds and living off without working for anybody else.

Point 7: With so much money coming in every month, life style changes and expenses on luxuries like foreign trips, electronic gadgets tend to increase. These eventually reduce the surplus every month.

Point 8: Could have chosen not to close the home loan and continue getting tax benefits. The money could have been used to earn hefty interest.

Point 9: Plan of taking another loan (>2 Crores) and use the monthly surplus to pay EMIs can be a big risk as it greatly reduces the free cash available every month.

Point 10: Plan of starting a money lending business is a big no-no if one gives any weightage to peace of mind.

Point 11: All the proceeds from sale of property could have been put in debt funds (50% Growth, 50% Quarterly payout). After decent quarterly payout accumulation, the money could have been invested in Equity Mutual Funds and Residential plots in small towns as in long term, only MFs, Direct stocks and Land are game changing wealth creators.

Point 12: This person should not have quit his day job until his planned business had kick started. Any business started after inheritance is more of a time-pass and chances of it succeeding are pretty low.

These are few of the major points which came out of the discussion which took place in comments of the post. I personally do not subscribe to quite a few like not paying off loan (I love being debt free). But I also think that few of points like expenses related to properties are quite valid.

Overall, I think the approach taken has been quite prudent, driven by common sense and most importantly focused on generating cashflows. But finally, only time will tell whether its correct or not.

What I told a frustrated guy in job. At 37, he retired last month – Part 2

Before I continue from where I left in part 1, I will briefly summarize what happened earlier for benefit of new readers…

A few years back, I met a guy who was frustrated with his job and life. He had a big home loan, was earning decently, but just sufficient to make his ends meet every month. Surprisingly, he had a plot of land worth several crores which he till that date, had failed to utilize productively. 

In part 1 of this post, I suggested following 5-point action plan to him:

  1. Sell the land & use the money as described in steps 2 to 5.
  2. Pay off the home loan
  3. Create an emergency fund
  4. Set aside money in fixed deposit which would provide monthly interest income equivalent to his monthly salary.
  5. Buy flats and rent them out to create additional streams of income.

Now let’s continue with what happened next…

This guy gave me a call last Sunday and told that he had actually thought a lot about what I told him two years back. He then discussed the approach with his parents and other family members before taking a final call 6 months back.

What he did then is summarized below:

  1. Six months back, he sold off the plot of land for Rs 9 Crores (post tax).
  2. Almost instantly, he paid off and closed his home loan of Rs 70 Lacs.
  3. Parallely, he created an emergency fund of 30 Lacs to cover his family’s expenses for next 24 months.
  4. Five months back, he parked Rs 4 Crores in Fixed deposits, which now provides him with a post tax monthly interest income of more than Rs 1.75 Lacs (Much more than what he drew as his last salary).
  5. In next two months, he bought 7 flats worth Rs 3 Crores and managed to put 5 of them up for rent. Rental income from these 5 flats is more than Rs 80,000 per month. He is still waiting to put remaining two flats on rent.
  6. Just two months back, he bought a small warehouse (godown) for Rs 1.1 Crore. As of now, he is pretty close to cracking a deal with a logistics provider for renting out the property. Probable rental income from this property is expected to be around Rs 75,000 every month.
  7. With home loan paid off, and earning in excess of Rs 3.2 Lacs a month without going to office for somebody else, this person quit his job (read retired) after celebrating his 37th birthday last month.

How to use your inheritance
A brilliant example of how to use your inheritance

Astonishing…isn’t it? How life can change with one simple decision. 

A reader commented in part 1 of this post that this guy was simply lucky to have inherited such a plot of land. 

I am not sure whether its right to give all credit for this guy’s success to luck. Agreed that you need to be lucky to inherit something like that. But I assure you, mentally and emotionally, it’s not an easy decision to sell inherited properties. It’s a tough call to make. It may seem simple up front. But it is quite a difficult decision to sleep with. Anyways, we are not trying to judge anyone or anyone’s luck here.

The fact is that this guy does not need to work again for anybody else.

And for emphasis, I repeat.

This guy does not need to work again for anybody else.

And just to give you all an idea of how a person’s decision making changes when passive income starts flowing in….this person told me something, which will further astonish you.

He is currently earning Rs 3.3 Lacs from his investments. With renting of two additional flats, he might start earning close to Rs 3.7 Lacs. He told me that frankly speaking, he did not need more than Rs 50,000 every month for his normal expenditures. This left him with Rs 3.2 Lacs surplus every month. He himself suggested that he was thinking of choosing between the following 3 options to park his surplus funds:

  1. Take property loans (approx Rs 2.5 Crores) which would use up this Rs 3.2 Lacs in EMI. The property in turn could again be rented out to generate more cash.
  2. Put money in stock markets using SIPs in good mutual funds and direct equity investments.
  3. Start a small money lending business.

For the time being, it’s irrelevant what I suggested him and what he eventually chooses to do. But this tells how a person starts thinking of ways of making money once he is out of the mad rat race of getting salary every month. The decision making and thought process changes completely.

We talk about value unlocking in properties held by companies. And here we have an exceptional example of how normal people like you and me can unlock value from existing properties. Once unlocked, the money needs to be managed as prudently as possible. And with systematic approach like the one taken by this person, its now money which is creating more money.

By the way, he is not frustrated any more. 🙂

What are your thoughts on this?

______


What I told a frustrated guy in job. At 37, he retired last month – Part 1

Isn’t this like a dream come true for all of us? Atleast for those of who are not working for themselves but for somebody else?

This post is about a person, with whom I had a casual chat over lunch some two years back. At that time, I (in my wildest dreams) could not have imagined that this talk would have such a big effect on his life.

But as it has been rightly said in Alchemist,

“When you want something, all the universe conspires in helping you to achieve it”

…in hindsight, it now seems that our little chat was the catalyst for something big which was about to happen in that person’s life.

He called up last Sunday to thank me for the little chat I had with him two years back.

At first, I did not realize what he was thanking me about. But when he told me everything, it was like a jaw dropping moment for me.

I will share this story in two parts…

And the first part of the story goes like this…

While doing my MBA internship in an organization, I came across a guy who looked quite old for his age and was a quite frustrated with his life. One day while having lunch together, he became aware of my interest in stocks and wealth creation in general.

And this got him started. He then told me quite a lot about his personal and financial life.

Frustrated Man At Job
 

He had been working in that organization for last 15 years. He was frustrated because though he was earning well, he was still barely breaking even every month end. He stayed in a decent 2BHK flat in New Delhi, which he had purchased 2 years back using home loan. The loan still had almost Rs 70 Lacs of unpaid amount. And this is what ate up almost 60% of his salary. Apart from the house, he had almost nothing to show for savings. To be exact, he just had a couple of lacs in PF, and less than a lac in fixed deposits.

But he had something else which could be a game changer.

Sometime back, he had inherited a plot of land.

And this plot of land was worth almost Rs 7 Crores at that time!! Yes. You read it right. It was worth more than 7 Crores! And as of then, that plot of land was lying vacant and was not suitable for cultivation.

I was surprised when I came to know of this. I was surprised that even after being a big Crorepati (many times over), he was still working for someone else, and was unhappy with his finances!

What I then told him was simple common sense and none of the usual financial gibberish you get to read on this site 😉

I told him that if he was ready to take a decision based on simple common sense, his life would change for the good. But for that he would have to part with something which he had inherited. And that in itself would require a lot of emotional will power.

He seemed quite eager to know what I planned to tell him. And what I told him is listed in 5 steps given below:

  1. Sell that plot of land and use the money as described in step 2, 3, 4 and 5.
  2. Pay off the home loan of Rs 70 Lacs
  3. Create an emergency fund
  4. Set aside money in fixed deposit which would provide monthly interest equivalent to his monthly salary.
  5. Buy flats and rent them out to create additional streams of income.

This is what I suggested him two years back. And last Sunday, I received a call from him.

But I will share rest of the details about why he wanted to thank me in part 2 of this Post.

 

Mailbag: I have a loan. Should I Pay It Off Before Investing?

Note – I have written about Paying Off Loan Vs Investing for Future debate in detail recently. You might want to read that article – Pay Off Loan or Start Saving & Investing?

In this post, I am trying to give a suitable response to mail I received from a reader named Shivangi. A part of her mail is given below:

I have a loan with outstanding amount of Rs XX lacs. I want to save and invest for future also. But everyone in my family and  friends are telling me to clear off my loans before even thinking about saving or investing for future. Please advice if this is a prudent thing to do or whether one can clear loan and invest parallely?

To be honest to everyone, I may not be the best person to answer this question as I myself have not been in this kind of situation. But I will try to arrive at some conclusion using rational and common sense as my tool.

Readers are welcome to share their own suggestions for Shivangi in comments section.

Mailbag Readers Question Answered

Two Important Considerations

One thing which is not known here is the type of loan which Shivangi is referring to. This is important because different loans have different interest rates and different tenures. For example,

Home Loan : 12% : 20 Years

Personal Loan : 20% : 1 Year

Car Loan : 12% : 5 Years

Loan from Family : 0% : Flexible Tenure

And so on…

Another important thing which needs to be considered here is that when one is planning to invest or save, what is the expected rate of return?

This is because if you are paying 20% in interest for a personal loan, and you want to save your money in fixed deposits, which give an after tax return of 6%, then you are really not being financially intelligent.

Once you have knowledge of these two key important pieces of information, i.e. Interest Rate (&Tenure) of Loan and Expected Rate of return for investments, you need to do a little bit of prioritization…
Debt Prioritization

Now this is very important to understand. A loan taken to invest in a property, which brings monthly rent may not be a bad loan. It is creating an asset which in turn will become a cash-generating machine. But if you buy a car at same interest rates, it is a bad loan as the value of car would depreciate with time. And it will not earn you anything during the time you use it (unless it’s a commercial vehicle).

Please note that by using the word ‘BAD’, I do not mean the bad loans which are a major concern for PSU banks.

Then there is credit card (type-of) debt. Almost everyone will tell you that credit card debt is bad. And generally speaking, they are right. The effective annual interest rate of credit cards is close to 40%!! So in case you do have credit card debt, you should target to clear it off as soon as possible and with a priority greater than anything else.
5 Steps To Invest & Pay Off Loans Simultaneously

Pay Off Loan Or Invest & Save
The Decision

All in all, it is indeed difficult to create an investment or savings portfolio, if you have number of loans running. But it is not impossible. Read the steps below and then I will tell you the most important thing:
  • First of all, you need to recognize the high interest loans (credit cards, personal loans).
  • Get rid of them as soon as possible.
  • Now pay off loans taken to buy liabilities (cars, gadgets) which do not produce a stream of cash.
  • Initiate creation of an Emergency Fund which takes care of unforeseen money requirements.
  • Now if you have any long term, low cost loans (property loan) running, you can think of investing simultaneously as you go on paying off that loan.

And now for the most important and toughest part…

Before you even think of following the above steps, you need to be willing to change your lifestyle as well. And that is because you can only make sensible financial decisions when you are ready to temporarily change and cut down the discretionary expenditures. By discretionary expenditures, I mean buying of goods and services which can be postponed till the time you are financially secure. Just sometime back, I was shocked to know that people are buying wrist watches on monthly installments!! Now according to me that is heights of financial stupidity.

Anyways.. I hope that above information helps Shivangi in her efforts to pay off loan and simultaneously create a stable investment portfolio.

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