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Combination of EMI and SIP can save you lot of money

What if your Home loan tenure is reduced without increasing EMI, even if the interest rate remains the same? Sounds interesting? Read it.

In year 2010, One of my friend bought a flat in Ahmedabad, for which he took the home loan of Rs 25 Lacs from a bank. At that time the interest rates were around 9.60 %. So, he decided to take the loan for the maximum tenure available, i.e. 20 years as he could afford the EMI of Rs. 23,466/-.

The bank RM came to his office for completing the paperwork. While filling the forms he asked him about the tenure which he would like to go for. He told him to go for maximum tenure i.e. 20 years. Bank’s RM told him, “Sir maximum limit is not 20 years it is 30 years”. According to his calculation he was ready for paying  Rs 23466/, an EMI amount for 20 years of tenure considering 9.60% interest and Loan of Rs 25 Lacs.

So if he chose to go for 30 year, EMI would be lesser. I tried to help him to do the exact calculation and ended up with some unique Idea which I am sharing through this article. The EMI for the 30 years tenure was worked out to be Rs 21204/, resulting into the saving of Rs 2262/ per month  into the EMI. So I advised him to go for the longer tenure i.e. 30 years.

Now financially and mentally, he was ready to pay for Rs 23466/ of EMI per month. So he decided to start an SIP of this Rs 2200/- (saving in EMI due to increased term) and to use the amount accumulated through this particular SIP to repay the Loan into the future.  I did some calculation in excel to check with the help of this combination of reduced EMI and SIP, how would it affect his loan repayment schedule.

My older SIPs were giving me some 18% kind of a CAGR, while doing the calculation I assumed that his future SIP would generate 15% CAGR. I found out that with this combination and assumed return of 15% CAGR from SIP, He can repay the loan in just 17 years.

Sounds interesting?

Let me explain,

Case 1: 20 years loan – Outflow (EMI – 23466)

Case 2: 30 years loan + SIP of saving into the EMI (EMI 21204 + SIP 2262 = Total 23466/-)

In both the above cases his monthly outflow is same, only difference is into the methodology. In first case he is only paying EMI in second case by increasing tenure he is making saving into the EMI and doing the SIP of that saving, making his monthly outflow same as that in case 1.

After 17 years, the value of his SIP of Rs 2200/- per month assuming the 15% CAGR* would be approximately Rs 21.29 Lacs, which he can use to fully repay the Home Loan outstanding. In other words, the outstanding loan principle amount would equal to the Fund Value of SIP after 17 years.

In the whole process He would pay 36 EMIs less compared to Case one, making an absolute saving into the EMI worth Rs 10.86 Lacs.

In Tabular Form :

If you are planning to buy the Home loan and if you have decided to take the loan for shorter period then you can use the above idea to save some EMIs. So if you have decided to go for 15 years of tenure and your bank is ready to provide you maximum tenure of 25 years, I suggest you to go for the higher tenure and utilize the monthly saving into EMI due to increased tenure to start an SIP into the some good diversified equity mutual fund.

If you have already taken the loan you can still utilize the above idea by asking bank to increase the tenure or you can also transfer your loan from one bank to another and while doing so, go for the maximum tenure.

Thus, by selecting the maximum tenure and doing the SIP can help you repay your loan earlier. The return assumed into the above calculation is not the guaranteed return.

*The return showcased is the assumed return and is not to be treated as any assurance or guarantee.

Mutual Fund investments are subject to market risk. Read all scheme related documents carefully before investing.