Top 3 Financial Dilemmas Solved

By BankBazaar | July 6, 2016

Top 3 Dilemmas

Should I take the car or bike to work today? Should I have cereal at home or order breakfast at work? Should I buy the blue shirt or the red one? Decisions are a part of everyday life. However, as Harper Lee says in ‘To Kill a Mockingbird’, “So far nothing in your life has interfered with your reasoning process.” You can use this reasoning ability of yours to solve a dilemma in minutes. However, financial dilemmas can be a bit tricky. That’s why we’re going to give you a hand and help you solve a few commonly faced ones.

Dilemma Number 1: Prepaying your Home Loan vs Investing in Mutual Funds

The Problem: You get a lump sum amount such as an annual bonus. Now, should you use it to pay off a part of your loan or should you invest it in Mutual Funds to earn rich returns? Tough one, huh?

The Solution: There are two cases where prepaying your loan would make sense:

  • You have a floating rate of interest on your Home Loan and interest rates are rising.
  • You got the loan recently (between one and three years ago) and the interest component is high.

There are two cases where investing in Mutual Funds would make sense:

  • You are getting tax benefits on your Home Loan and prepaying might reduce these benefits.
  • Cost of the loan minus tax benefits would be much lower than the returns you will get from Mutual Funds.

The Calculation: Suppose you have a Rs. 30 lakh Home Loan with an interest rate of 11% p.a. and a loan tenure of 15 years. If you prepay Rs. 2 lakh at the end of 3 years (after taking the loan), you would save Rs.4.81 lakh of interest on your loan. If the same was invested in a Mutual Fund earning a return of 10% p.a. for 10 years (assuming you don’t reinvest the return earned), you would get Rs. 4 lakh. So, in this case, prepaying your Home Loan is more beneficial than investing in a Mutual Fund.

Dilemma Number 2: Liquidating investments vs Taking a Personal Loan

The Problem: You are short of money to meet a goal. But you don’t know whether to liquidate your investments (such as Fixed Deposits) or take a Personal Loan.

The Solution: It would be best to take a loan only when you know that you can repay it quickly. Also, there should be no foreclosure charges or no/low processing fees as these might increase the cost of your loan. If you opt to liquidate your investments (that were saved for some other purpose), be sure to replace them quickly.

The Calculation: Suppose you need Rs. 5 lakh for your kid’s higher education. Assume that you are planning to take a Personal Loan for 3 years at an interest rate of 12%. Here’s what it would cost you. The total interest that you would need to shell out would be Rs. 97,858. However, if you decide to liquidate your FD with an interest of 10%, you would lose an interest amount of Rs. 1,51,200. If you were to prepay the loan by a lakh at the end of each year, your interest would go down to Rs. 53,220. So, it makes sense to take a loan rather than losing interest on your FD.

Dilemma Number 3: Making a higher down payment vs Saving for woodwork

The Problem: You just bought a house and have spare money. But you don’t know whether to make a higher down-payment or save it to renovate your home.

The Solution: Making a higher down-payment would reduce the cost of your loan. But this makes sense only when you don’t borrow again to renovate your home. The best solution would be to use a part of your savings for higher down-payment and the other part to renovate your home.

The Calculation: Suppose you have Rs. 15 lakh on hand after purchasing a home using a Home Loan. Let’s assume you took a Home Loan for Rs.50 lakh for 20 years at an interest of 10% and the down payment is Rs. 10 lakh. Essentially, the loan amount would be Rs. 40 lakh. In this case, the total interest would be Rs. 52,64,208. Suppose you make an extra down-payment of Rs. 5 lakh and save Rs. 10 lakh to renovate your home, your interest would go down to Rs. 46,06,182. That is a whopping savings of Rs. 6 lakh and you also have money for your woodwork.

See how easy it was to make a decision with a just a bit of calculation? So remember, if you’re ever in a financial dilemma, whip that calculator out and start tapping away! The numbers will tell you what decision to make. And if that decision involves taking a loan, you know where to go.

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Category: Money Management

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