For most people, buying a dream home will probably be their single largest big-ticket expense. With the Reserve Bank of India capping home loan LTV (loan to value) ratio at 90%, 80% and 75% for home loan amounts of up to ₹30 lakh, ₹30-75 lakh and above ₹75 lakh respectively, even the down payment requirement for home loans goes up to several lakhs.
The size of the down payment money, coupled with the urge to buy their dream home, force many to make financial mistakes, which can have an adverse impact on their financial health in the long term.
Here are some of the common mistakes that borrowers make while sourcing home loan down payment money.
Availing personal loans
Home loan lenders usually prefer to lend to those with fixed obligation to income ratio (FOIR) of 50-60%. This ratio denotes the proportion of the loan applicant’s monthly income used for servicing his fixed monthly obligations such as his existing EMIs, insurance premiums and the EMI for his new home loan.
If the home loan applicant avails a personal loan to finance his down payment component, the new EMI of his personal loan will further reduce his FOIR, thereby reducing his overall home loan eligibility. Additionally, applying for personal loans with multiple lenders can also reduce the credit score as any new loan application is reported to the credit bureaus who, in turn, reduce the credit score by a few points. A reduced credit score will further bring down his home loan eligibility.
Using emergency fund
This fund refers to the part of your savings set aside for dealing with unforeseen expenses and meeting unavoidable expenses in case of loss of income arising out of illnesses, job loss and disability. The size of this fund should cover the mandatory expenses of at least six months, such as your existing EMIs, daily household expenses, utility bills, children’s school fee, insurance premiums, medical expenditure, etc.
If you use up your emergency fund for making the down payment, you will be forced to redeem your investments earmarked for other crucial financial goals or avail loans at high interest rates.
Using retirement corpus
The increasing number of nuclear families and absence of universal old-age social security have increased the importance of having adequate post-retirement corpus. Increasing healthcare costs and rising life expectancy have also increased the risk of running out of retirement savings. However, the long time horizon available for creating retirement corpus leads most to ignore its importance. As a result, many who regularly save for their retirement corpus through regular contributions to EPF, PPF or even mutual fund end up redeeming funds from their retirement corpus. The flip side of doing so is that restarting your contribution from scratch or at depleted levels would take longer to create adequate corpus.
For example, if a 25-year old investor starts an SIP of ₹10,000 per month in an equity fund generating an annualised return of 12% p.a., he will have a corpus of ₹6.43 crore on turning 60. However, if he withdraws the entire corpus after six years of investing for making his home loan down payment, he will redeem ₹10.50 lakh assuming the same rate of return. If he starts investing in the same fund for re-building his retirement corpus immediately after making his home loan down payment, he will have a retirement corpus of just ₹3.09 crore on turning 60. The new corpus will be half of what he would have built, had he stayed invested.
Redeeming children’s education corpus
The rising cost of higher education is worrying for both parents and children. For most parents, availing an education loan has become the only source to finance their wards’ higher education cost. On the other hand, higher loan amounts can leave children with a sizeable debt burden to service which, in turn, can adversely impact their savings during the initial stages of their career.
The best way to avoid such high-cost debt is to start building your children’s education fund early on. Start early with regular investment at periodic intervals, preferably through SIPs. This will allow you to create the target corpus at much lower instalments. However, the same issue of long investment horizon can entice many to redeem their children’s education corpus for arranging down payment money. As explained in the case of retirement corpus, restarting your contribution from scratch or at depleted levels would mean it would take longer to achieve the target corpus for your children’s education.
Conclusion
Instead of availing a personal loan or redeeming your emergency fund or other investments for crucial life goals, start saving early for home loan down payment by regularly investing in mutual funds through SIP. Use an online SIP calculator to find out the monthly investments required to create your home loan down payment corpus. Invest in ultra-short and/or other short-term debt funds if you wish to create substantial corpus within three years. Invest in balanced advantage funds if you wish to create this corpus within 3-5 years. Opt for large cap or multi-cap equity funds if you have over five years to create the corpus.
(The author is CEO & Co-founder, Paisabazaar.com)
