Home Loan: Taking a home loan is a big financial decision, and to repay it, a heavy EMI (Equated Monthly Installment) has to be paid every month. Usually people try to finish the home loan soon so that they do not have to pay much money on interest. In such a situation, reducing the interest burden of home loan by investing in SIP (Systematic Investment Plan) seems to be an attractive and sensible option.
It is important to understand both the benefits and risks with the strategy of reducing the burden of home loan through SIP. If implemented correctly, it can help strengthen your financial position. Let us know what this strategy is, how it works, and what risks can be involved in it.
What is EMI + SIP strategy?
EMI + SIP strategy means that along with your monthly EMI, you invest a fixed amount every month in mutual funds through SIP. Its purpose is to create a large fund in the long run, so that you can reduce the burden of your home loan or repay it before time.
For example, suppose you have taken a home loan of Rs 80 lakh. If you repay it in 15 years, your EMI will be around Rs 78,500 (assuming an interest rate of 8.5%). But if you take the same loan for 20 years, the EMI reduces to around Rs 69,000. The difference between these two, i.e. around Rs 9,500, you can invest in SIP every month.
How much can be the profit in 20 years?
Now if you invest Rs 9,500 every month in a good index fund or equity mutual fund, and suppose you get an average annual return of 12-13%, then after 20 years this SIP can create a big fund. As per the calculations:
Value of SIP in 20 years: At Rs 9,500 per month, assuming a 12% annual return (with compounding), your investment can reach around Rs 95 lakh to Rs 1 crore after 20 years.
Help in loan repayment: You can use this fund to repay the remaining amount of your home loan before time.
Additional savings: If you have money left after repaying the loan, it can be a big advantage for your financial security.
Advantages of this strategy
Interest savings: Long-term loans have lower EMIs, allowing you to invest additional funds. The returns from SIP can be higher than the loan interest rate, reducing your overall interest cost.
Wealth creation: SIP not only helps in loan repayment but also creates a large corpus for you in the long run.
Flexibility: If your financial situation remains good, you can increase the SIP amount or top-up from time to time.
Is this approach right for everyone?
While the EMI + SIP strategy looks attractive, it also has certain risks that should not be ignored:
Market risk: Investing in mutual funds is subject to market fluctuations. If the market performs poorly or returns are lower than expected, this strategy will not be as effective. For example, if your SIP returns are 6-7%, which is lower than your loan interest rate (8-9%), then this strategy may prove to be detrimental.
Financial stability: This strategy works only if your income is stable and you can pay both EMI and SIP every month. If you face unemployment, loss of income, or other financial crisis, it may be difficult to maintain both SIP and EMI.
Long-term commitment: This strategy is for a long term of 15-20 years. If you stop SIP midway or withdraw the investment prematurely, you will not get the expected benefit.
Loan interest rate: If your home loan interest rate is very low (for example, less than 7%), then the benefit of investing in SIP may not be as attractive, as there is uncertainty of returns in the market.
Things to consider before adopting this strategy
- Assess your financial situation: Make sure you can afford both EMIs and SIP for a long time. Keep an emergency fund so that your investment is not affected in unforeseen circumstances.
- Choose the right fund: Invest in equity mutual funds or index funds, which can give good returns in the long term. Before choosing a fund, look at its past performance, credibility of the fund manager, and expense ratio.
- Loan prepayment rules: Understand the rules of your home loan. Some banks may charge a penalty on prepayment, which can affect your savings.
- Consult a financial advisor: If you do not have much knowledge about the market or investments, consult a certified financial planner.