One of Rajiv’s smart decisions just after he married Suparna was to invest a modest amount in a mutual fund.
This was a significant part of his savings.
Rajiv also started a systematic investment plan (SIP) in a mutual fund.
He made these two decisions considering his future financial needs.
Little did he know that these investments would help him buy a property without straining his finances.
We will see how you can also use your mutual fund investments to buy a property.
Let us dive in.
SWP — What is That?
The SWP (Systematic Withdrawal Plan) acts opposite to the Systematic Investment Plan (SIP). While SIPs help you invest systematically, SWPs help you liquidate the investment systematically to generate a fixed income on a monthly or annual basis. A fixed portion of your investment is liquidated and the proceeds are moved to your linked bank account. This gives you the needed liquidity and allows the remaining investment to grow. If your withdrawal rate is lower than the rate at which your investment is compounding, you will never run out of money,
Using the SWP in your mutual fund investments can be an effective tool that can assist in the timely repayment of home loan EMI. It is important to know how SWPs work, and their pros and cons before you use them for repaying your home loan EMIs.
You can set SWP in a manner that matches your EMI obligation. In this way, your repayment is taken care of by SWP while the rest of the money can continue to grow in equity markets.
But Shouldn’t You Pay a Higher Down Payment?
It’s a valid question.
A higher down payment will keep the home loan amount low and consequently, the EMI will remain low.
However, if you use SWP to pay your EMIs, some of your investment will grow while your EMIs will also be paid.
You do not need to liquidate all your investments.
It is viable because the typical home loan interest is usually not more than 8.5-9% while the mutual fund returns are higher over a long period.
In the last 10 years, Nifty 50 has grown at 14% CAGR.
Sounds Like a Plan, but What are the Risks?
It is to be to be remembered that this plan is not for everyone.
It is for you if you have a long horizon and are prepared to withstand some volatility in the interim period.
Home loan interest rates are spread evenly while mutual fund returns can be lumpy over short periods. Although over a long period of 10 years or more, mutual funds returns are substantially higher than the average home loan interest rates during the same period.
You need to earn additional returns of at least 4% CAGR compared to your loan rates to conserve your capital. More importantly, this difference in returns should continue for the entire lifecycle of your loan.
However, you must remember that mutual funds are subject to market risks and investors may not always get a desired level of return. Consult a financial advisor before using the SWP setup for repaying the loan EMI.
Let’s Get Down to the Details
The key here is to begin an SIP as early on in your career as possible. Though you may not be able to afford a high EMI immediately, start an SIP as soon as feasible. The longer the duration of the SIPs, the easier it will be to fund your EMIs. This does not necessarily mean that you need to have high-value SIPs in place for decades to make this possible. Consistent and sustained SIPs over a reasonable tenure are vital.
Once you have a reasonable investment corpus in place, you can begin withdrawing amounts to fund the EMIs through a Systematic Withdrawal plan (SWP) while continuing to contribute to the fund through SIPs.
Let’s assume a conservative SIP amount initially (All figures are in Rupees).
SIP monthly amount: 17,000
Annual accretion: 5%
The initial period of SIP: 5 years
The assumed long-term rate of return: 12%
Now, let’s assume that the home loan is availed of after 5 years.
Home loan amount: 50,00,000
Interest rate: 9%
Tenure: 20 years
EMI: 44,986
Once the home loan is availed, an EMI of Rs 44,986 would have to be paid each month. Instead of paying this amount outright, the escalated SIP can be continued each year and the EMI amount can be withdrawn from this accumulated investment corpus through an SWP.
In this example, at the end of the loan tenure not only is the loan completely paid off through SIPs but the investor can also be left with an amount of Rs 10,83,375 in his investment corpus.
Let’s see how that happens.
The total amount of SIP paid in 25 years (5% accretion each year): 97,36,328
Less: the remaining value of the investment at the end of 25 years: (10,83,375)
Net outflow: 86,52,943
Total EMI amount that would have been paid (if not funded through SIP): 1,07,96,711
Effectively the loan amount of Rs 50,00,000 has been repaid by a net outflow of Rs 86.52 lakh through SIPs vis-à-vis Rs 1.08 crore through outright payment of loan EMIs. This can result in a saving of Rs 21.44 lakh.
In this example, considering a conservative annual accretion of 5%, the SIP which began with Rs 17,000 per month in Year 1 reaches Rs 54,827 in the 25th year. (initial 5 years plus 20 years of loan).
Had there been no EMI payment, the corpus would have grown to Rs 4,64,91,364. As you are systematically withdrawing to pay EMI, you are foregoing this growth in exchange for owning a roof over your head.
However, Remember This
The rate of withdrawal should be lower than the rate of growth. In a country like India where inflation is usually high, a difference of 4% may not be sufficient. Aim for a 5-6% difference, if possible.
Be mindful of the applicable tax rate. You can take advantage of Section 54F of the Income Tax Act in this regard.
Mutual funds are dependent on the stock market and some years can have negative returns. Please consult your financial advisor before investing in mutual funds.
If you want professional advice on any facet of home purchase, contact us today.
