Let us understand some facts through a conversation between a financially educated dad and his son.
Let us understand some facts through a conversation between a financially educated dad and his son.
Son (To dad): I want to invest Rs 10,000 every month in Mutual Funds through two SIPs of Rs 5000 each.
Dad: Why two funds?
Son: As Warren Buffet says ‘Never put all your eggs in one basket.’
Dad: That is true, but he said this in some other context. Here, ‘basket’ means Gold, Real Estate, Equity and Bonds. Tell me about your plans for buying that 3 bedroom flat.
Son: My salary is Rs 1,00,000. The total cost of my flat is Rs 75 lakhs. I have planned to pay a down payment of Rs 25 lakhs take a home loan of Rs 50 lakhs for 20 years and my EMI will be Rs 50,000 per month.
Dad: Great. And what about your current monthly expenses?
Son: Currently, my expense is Rs 30,000 monthly and I can save an extra Rs 10,000 when my car loan EMI is over.
Dad: So, just calculate how much percentage of your savings will into paying EMI.
Son: around 85%.
Dad: That is my worry. You are putting all your eggs in one basket, ie, Real Estate.
Son: But, it is necessary, I will save tax on this.
Dad: Oh, what tax will you save on Rs 2 lakh interest of home loan (As per IT rules, you can claim Rs 2 lakhs per year as a deduction)? You are in the 30% tax bracket, so you will save 30% of Rs 2 lakhs, ie, Rs 60,000 tax per year.
Son: Yes.
Dad: But my son, at the cost of interest of your home loan, your EMI is Rs 50,000 for 20 years. That means, you will be paying Rs 50,000 * 12 * 20 = Rs 1.2 crores to the bank against your loan of Rs 52 lakhs.
Dad continues to explain: Rs 1.2 crores - Rs 52 lakhs = Rs 68 lakhs of interest you will pay for 20 years. That means you are paying Rs 3.4 lakhs interest every year and you save Rs 60,000 tax every year. So, your total loss interest expense is Rs 3.4 lakhs - Rs 60k = Rs 2.8 lakhs.
Son: I never thought it in this way.
Dad: If you would have invested this Rs 50,000 through SIP for 20 years at the rate of 15% CAGR, you would have accumulated Rs 7.5 crores.
Son: What about the Rs 25 lakhs down payment?
Dad: At a rate of 15% CAGR, it would become Rs 4 crores in 20 years.
Son: Meaning a total of Rs 11.5 crores. My Rs 75 lakh flat for which I will be paying Rs 1.2 crores will never give me a return of Rs 11.5 crores in 20 years.
Dad: Exactly my point. Don’t just take a home loan to save tax. Invest in real estate only if you are able to find cashflow positive properties.
Son: Thank you, dad. You saved me money.
Dad: You are always welcome my son.
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