How Do You Build a Corpus for a Housing Loan Pre- payment?

* Use Power of Compounding..!

How do you build a corpus for a housing loan pre-payment?

Use the power of equity, says Mr. BALAJI RAO

Power of Compounding..!

While saving & investing, several people ignore the power of compounding and miss out on the long term benefits of equity oriented instruments.

Investors avoid equity more out of ignorance than from fear of the risk itself. 

Thus, when people want money for a housing loan down payment, they will sell jewellery, take personal loans or  / break Fixed Deposits (FDs) but very few will plan in advance through an asset allocation based investing plan, where they could have invested a regular sum in equity to create a neat little amount. 

The same principle applies to borrowers wanting to pre-close a housing loan. It is a struggle to create a large corpus over, say, 10 (ten) years that you could use to close your loan.

If you took a housing loan of Rs. 20 lakh in March 2003 at 10.5% interest rate, you would have to pay an EMI (Equated Monthly Instalment) of Rs.19,968 till March 2023.

As per the amortisation table, at the end of 10 years, in March 2013, the total contribution towards interest would have been Rs. 18,75,906 and the amount towards the principal would have been Rs. 5,20,206.

If the home loan is to be pre-closed at this juncture, the total outstanding is Rs. 14,79,794.

How can a borrower arrange to have about Rs. 15 lakh towards pre-payment by the end of 10 years?

This is where the power of compounding comes in.

Section 80C of the Income Tax Act allows you to invest Rs. 1 lakh in various tax-saving instruments in order to claim exemptions.

The Equity Linked Savings Scheme (ELSS) is one such instrument.

To claim the exemption, you can invest your entire Rs. 1 lakh in ELSS, which is locked for three (3) years from the date of investment. The subsequent gains are completely tax-free.

However, typically, for a housing loan borrower most tax exemptions come from the principal component of the EMI, besides contributions to PF, tuition fees, insurance premiums & other such investments.

If you have anything left over to claim the Sec. 80C exemption, then definitely consider ELSS opportunities.

For the above example, if you had invested, say, Rs. 25,000 in any one well known ELSS scheme every March from 2003 to March 2010, your total contribution of Rs. 2 lakh would have grown to Rs. 7.72 lakh when you withdraw it in Feb 2013 (After the three year lock-in), a four-fold growth in nearly ten years. You can double your ELSS investment to fully prepay that loan.

Using the HDFC Tax Saver Fund as an illustration, the Net Asset Value or  / NAV of the scheme was Rs. 18.71 on 17 March, 2003, which grew to Rs. 235.89 on 16 February, 2013 at a rate of Rs. 28.84 per cent per annum CAGR.

The long-term gains are tax-free and creating a corpus of Rs. 7.72 lakh by investing just Rs. 25,000 each year for eight (8) years is definitely worth considering.

Equity might be risky. But, the power of compounding can not be ignored. Hire a qualified financial planner to plan equity-linked investments that suit your risk & financial profile.

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