Over the last few weeks, many readers have asked if they can sell their mutual funds or other investments to partially pre-pay their home loans due to steep loan interest rates after the RBI Repo rate hike. One reader wanted to liquidate his entire MF holdings to part-pre-pay and decrease investments to increase the EMI further. A discussion on what can be done.
First of all, extreme decisions are off the table. Whatever we do, we must balance our debt with our investments and expenses. Many people make the mistake of allowing the EMI to be as large as they can afford to (often decreasing investments), and they would be feeling the heat now to pay the extra EMI.
A home loan is the number one enemy of retirement planning. Borrowers often recklessly dip into their retirement corpus for either an initial down payment or part payment. Almost always, a home loan implies the borrower is investing lower than necessary for retirement.
Interest rate hike only makes things that much more difficult. What are the options available after the rate hike?
1. Pre-close the loan. Even if it makes sense, very few can manage this. We do not recommend this.
2. Partially pre-pay the loan by redeeming from investments. We do not recommend this either unless someone has already achieved their goals and has some corpus to spare.
Partial pre-payment using salary hikes or bonuses should be done regardless of interest rate changes.
3. Accept the higher EMI for the same loan tenure. This is the smartest choice, provided you can afford to pay the higher EMI, even if it means lowering your monthly investments.
4. To begin with, many borrowers try to maximize the EMI, not accounting for rate hikes. They are probably now feeling the heat and may be forced to increase the loan tenure at the same EMI. But this would mean being in debt longer and not being able to invest enough for long. This section is the worst affected.
Those with a stable job with retirement 20 years or more away can afford to increase the tenure by a little (as allowed by loan norms) to ensure investments are not affected (by the EMI hike).
In summary, we recommend borrowers not redeem their mutual fund or other investments to part-prepay the home loan. Already most of them will not be investing enough for retirement. If their existing net worth is further depleted to pre-pay, it can significantly erode the future growth potential of the corpus.
Accepting the EMI hike and reducing the monthly investments accordingly is the safest choice for most people. Those confident about their jobs can afford to either keep the EMI the same or increase it in part along with the loan tenure to ensure investments are not affected. However, it must be kept in mind that there could be future rate hikes.
In any case, any extra cash in the form of salary hikes or bonuses should be diverted to the loan account to pre-pay the loan. Those with overdraft loans should not divert too much cash into the loan account to reduce the interest payable. Long term financial goals should be the priority.
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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