FinZine- February Edition 2015

From the Macro-Economic perspective, most of the large economies like China, India and US have a stable Macro Economic condition. All these economies are at the cusp of announcing new policy initiatives. Like, for example India is waiting for the budget to be released and so are all the other economies are also waiting for policy initiatives. However, what is happening in Greece took the centre stage in Europe. The austerity measures of International Monetary Fund (IMF) and Eurozone on Greece have resulted in bitterness in most of the population of Greece. As a result the previous government which supported austerity was voted out and the new ruling party was against the austerity. As expected there was a fiction between Greece and Eurozone on extending the credit lines. Due to this, there was a risk for Greece that it should repay 6.7 billion Euro loan back to European Central Bank (ECB) by July-August. However, both parties have signed an agreement that Greece has to come up with a plan for its economy with reduced austerity measures. This would reduce the fear of Eurozone collapse.

Emerging markets continue to underperform on the basis of GDP. Brazil and Russia have seen a contraction in GDP. However India and China, the key economies in the emerging markets, will drive the growth. The key change that happened in India is the change in base years for GDP calculations and inflation. The base year for GDP calculation shifted from 2004- 2005 to 2011-2012. As a result the new GDP is at 7.4% which closer to the expected growth rate of China which is at 7.5%. Similarly, base year for inflation is shifted from 2010 to 2012. Due to this the retail inflation i.e. Consumer Price Inflation (CPI) has moved from 4.28% to 5.11%. Currently, all the markets are waiting for the budget. As a personal finance organization ArthaYantra feels that the concentration on budget is high in India where the financial deficit policies should be announced across the year rather than during budget only. However, a good budget will boost the economy to go to the next level.

The interest rate has been steady for the last one month after the surprise rate cut by RBI. There is an expectation on RBI that it would further reduce the interest rate. Currently, RBI feels that the ball is in the court of the government. The government should come up with a progressive budget which should also address some of the structural issues which will contribute to inflation. Like, subsidy revenue, areas of economy which are increasing the supply side and economic problems that India is facing. With the new inflation calculation the Consumer Price Inflation (CPI) increased to 5.11%. In addition to this, the ten year bond yield stands at 7.7%.

Last month the RBI made an effort to increase liquidity by reducing the Statutory Liquidity Ratio (SLR) from 22% to 21.05%, SLR is the amount that banks have to keep as deposit with the RBI. The reduction in the SLR would increase the liquidity for the banks, so there is a scope for mobility to provide more credit. ArthaYantra continue to be bullish on the fixed income markets and feel that the higher duration bonds will provide greater returns to our portfolios. We expect a return of 10% from our bond portfolio to the overall portfolio for our premium customers. So, as of now, we hold the allocation on fixed income as they are.

Crude oil continues to hover around 50$ and the Brent Crude is around 60$. The reductions in oil prices have a major impact on India. Current account deficit (CAD) estimation for 2014-2015 reduced to 1.3% which was much lesser than the past estimation. The tail wind of the oil reduction has helped India on the current deficit. However, this cannot drive future GDP growth. The OPEC not reducing the production expected to regain some upward momentum and settle around USD 60$ a barrel. Though this would benefit the Indian economy as of now but wouldn’t last forever. So, the government should actually come up with new policy initiatives which should impact the GDP growth. We are awaiting how markets react according to the policies initiated by the government and take a step to allocate which helps to grow our portfolio value.

Buying a home is not a dream too big for the common man today as there are many feasible options available to him for achieving this dream. Owning a home has become easy by borrowing a major chunk of the cost of the home from the banks. However, the effort made to re-pay the loan through EMI is a big burden on the borrower for many years. A major part of earnings go towards EMI payments for the entire home loan tenure or till we fore-close the loan. Ideally all the EMIs shouldn’t exceed 40% of our monthly earning. If it exceeds 40%, it is better to fore-close the loan either in tranches or completely depending upon our payment capacity. However, fore-closing our loan is suggested only if it doesn’t disrupt our financial cycle.

The following 5 things need to be kept in mind before fore-closing a home loan:

Don’t foreclose the loan within first six months of the home loan tenure:

RBI had waived of the penalty charges on fore-closing the loan. This is hugely beneficial to the borrower. However, foreclosing a home loan within six months from the time we have taken the loan is not encouraged by many banks. Even if there are banks who offer this option, they would actually charge us a high processing charge. Moreover it will not make sense if we take a loan while we are capable of closing it in a very short span of time. If we have a lump sum amount then we should meticulously analyze where to park the amount before we fore-close our home loan.

Check Tax benefits of the home loan:

Typically, if we are fore-closing the loan then we wouldn’t be able to avail the tax benefits from the interest payment from the loan. But the principal paid can be claimed under section 80C up to a limit of 1.5 lacs which is partially taken care by our PF contribution and life insurance premiums. Here we need to make a firm decision whether we should really wait to avail these tax benefits or clear the liability if we have enough surplus amounts with us. In case we want to avail the tax benefit from the interest paid then we should wait for some years so that maximum benefit can be availed and then fore-close the loan.

Don’t miss to calculate the impact on other financial goals:

Fore-closing the home loan could have an impact on other goals and their achievement. Also it is not advisable to divert funds from other goals to fore-close a home loan. For example, to close the loan we might divert our retirement savings into fore-closing the home loan which is not at all advisable. It is important to demarcate our financial goals and save/invest accordingly to achieve those goals. Buying a home should be one of the goals but not at cost of other mandatory goals. The amount that you spend to fore-close the loan shouldn’t disturb your financial health. If we have less time to meet goals like Children’s Education, Retirement, etc. then it is advisable to postpone the idea of fore-closing the home loan for some time.

Earlier we fore-close the home loan, better is the benefit:

If we have enough liquidity flow in hand even after saving for our other goals then it is ideal to fore-close home loan in the initial years of the loan tenure. Banks take the major portion of EMI paid at the initial years into the interest component and very small amount is considered under Principal component. So, fore-closing at the earliest will help us save amount that is paid as interest to the bank. If we fore-close the loan when we near the end of loan tenure, then by that time we have paid most of the interest and only the Principal is left over. Hence the earlier we fore-close the home loan, the more we save on interest.

Measure Rate of return Vs Rate of Interest:

If we have enough liquidity with us it is advisable to invest into a diversified portfolio consisting of various asset classes, which would yield higher returns instead of fore-closing the loan. However, it is ideal to clear the liability if we are near to retirement or seek an early retirement. We should only fore-close the loan if the Rate of Returns on Investments are lower than the Rate of Interest being paid for the home loan.

Conclusion:

Foreclosing the loan does bring a respite from EMIs and the satisfaction of getting rid of a liability. It looks even more convenient when we have a lump sum amount available. However the trade-off between fore-closing the loan or investing the excess surplus for long term, has to be properly examined before taking the decision to fore-close the home loan. Even a small amount that is paid towards the Principal can reduce the interest amount paid to the bank but it is also important to seize other investment opportunities and take a better decision.

While we plan our finances to achieve financial goals like Children’s education, Retirement etc. we often ignore to plan for emergencies like ill health or loss of life which could adversely affect our financial health. Planning for contingencies should be the first step towards financial planning as occurrence of such an emergency can disturb financial life. It is prudent to plan for risk management while we plan our finances to fulfill our goals. Buying a simple insurance plan can protect us from a significant downside.

Health insurance is one of the most dreaded areas for the common man. While looking at the options available we should choose a plan which suits us better than choosing among options provided by the agents. The total coverage of the Health Insurance is one of the primary factors we need to consider along with other factors depending on our lifestyle. It is important to spend quality time to assess the Health Insurance Plan and ensure it suits our requirement completely. This would ensure that when needed most, our claim would not be rejected by the Insurer.

Here are few steps to keep in mind before planning to take a health plan.

Our company’s Group Health Insurance is sufficient:

Most of the employees think that the Group Health Insurance will cover the risk for our family and ourselves. However, these Insurance plans have defined limits. We need to check the amount of coverage, whether it would support our family members, if yes, then who among our family is eligible to be added to the beneficiary list. Most of the health insurance covered under this scheme is inadequate. Also this coverage would cease to exist as soon as we change our employment. So, it is ideal to take an additional health plan for us and our family members in spite of having group health insurance.

Most of the employees think that the Group Health Insurance will cover the risk for our family and ourselves. However, these Insurance plans have defined limits. We need to check the amount of coverage, whether it would support our family members, if yes, then who among our family is eligible to be added to the beneficiary list. Most of the health insurance covered under this scheme is inadequate. Also this coverage would cease to exist as soon as we change our employment. So, it is ideal to take an additional health plan for us and our family members in spite of having group health insurance.

Avoid Moral Hazards:

We should be honest in revealing all the facts regarding health while filling up the proposal form for the health plan. A serious mistake committed by many people is that they don’t disclose the complete and true facts. This comes under moral hazard and is considered as a fraudulent act by the insurers which ultimately lead to rejection of the claim. A few health plans do not require us to undergo any medical tests, but they would hardly serve the purpose when most needed. It is always advisable to take a health plan which requires us to disclose all the details regarding our health. Being truthful will always ensure that the chances of our claim being rejected would be minimal.

Don’t Seek Low Premium Plans:

At the time of taking a health plan, we might not anticipate the quantum of risk for which we would need coverage. This would mean that we might end up picking up a health plan that is inadequate and would not suit our risk needs. Usually we look for the premium amount while deciding a health plan. A low premium health plan need not necessarily be a good one. We should be prudent and select a health plan that addresses as many critical and non-critical illnesses as possible to cover risk to our health. However, this doesn’t mean that we should take a high premium plan but one should choose the plan by considering factors which is useful to us optimally.

Check the factors which impact the Premium:

Factors that impact the Premium are Co-Pay, Sub-Limits and Deductibles. In Co-Pay, at the time of claim some amount should be spent from your pocket. So, it will be wise if we go for a No Co-Pay option even if the premium payment is high when compared to Co-Pay. The next factor is Sub-limits in which insurers tend to put a cap on certain expenses on lodging. The type of lodging would also depend on the limit of the health plan. The other factor is Deductibles which means that we can not claim the complete amount until we pay the Deductibles.

So, it is ideal to choose a plan which is free from these factors.

Check the No-Claim Bonus:

Insurance companies would offer a no claim bonus on the sum insured for the next year if you haven’t made any claim in the past. Generally an NCB of 5% or 10% is offered by the insurers. It is advisable to go for a plan which has higher incremental NCB which would be at par with the increase in hospitalization expenses. This is because the NCB less than 10% would not make any difference at the time of claim.

Be firm on low Pre-Existing Exclusion:

Pre-existing Exclusion is the limitation for the Pre-Existing diseases which the insurer does not cover till a prescribed period of time. The maximum period for Pre-Existing Exclusion would be for four years. As we can not make a claim during period of Pre-existing Exclusion, it would be beneficial to choose a health plan which has a lesser Pre-existing Exclusion.

Know the disease-wise capping:

Even the small clause in the health plan will play a major role at the time of claim. There are some plans which have cap on certain ailments. In such case we cannot claim the total amount. So it is always good to spend some quality time on the health plans to study the features and choose the plan which is hassle free in nature and suits our profile.

Claim settlement ratio:

The claim settlement ratio usually rides the wave because people consider this as a major factor before they buy a health plan. We should check Claim Settlement Ratio of the Insurer before buying a health plan from them. The Claim Settlement Ratio is a measure of the number of claims that are pending and the number of rejected claims.

Unforeseen expenses:

There are expenses which may occur during treatment, like some tests not directly related to the ailment, which the doctor might want to conduct to rule out the possibilities, will not be covered. Other expenses which are not a part of health expenses like transportation charges, consumables, a stay outside city during the treatment or expenses of the attendant are also not covered.

Conclusion:

Expectation and reality are two entirely different things when it comes to Health Plans. We expect that our health plan would cover all the expenses at the time of claim, but in reality our claims get rejected or get covered only to some extent. This happens because of choosing inadequate health plans. So, it is important to choose a health plan by considering all the factors in detail. This process may consume time but once the plan is chosen proactively then our health plan can save us from medical contingencies.

Even having a sound health insurance plans may not be the only way out of such trouble. It is advisable to create some health emergency fund which may cover these expenses as well as those treatments which are not covered in any health insurance plan.

Buying a home is one of the most common financial goals in India. Buying a home would ensure you and your family a financial security. It will also save money that you pay for your rented house. During past decade buying a home has picked up tremendously because of the easy availability of the home loans. Banks have simplified the entire process of home loans to ride this wave which comes with a huge sentimental aspiration.

Banks make profit by easily giving a home loan to the borrower. Typically, 85% of cost of the property is provided as a home loan by the banks. The differential amount of 15% has to be borne by the borrower using his own savings/resources. Majority of the home buyers decide the home to be bought taking into consideration the EMI as their affordability factor. One pertinent question that haunts a home buyer always is “How much do I actually pay for my dream home?”.

We answer this question with a real life example and try to decode home loans under two heads, one is principal and interest. Second one is Tax implications.

Mr. Varma decided to buy a 3 BHK flat in an upcoming neighborhood in Hyderabad. The total cost of the flat including amenities was INR 63, 00,000. As per norms he paid 15% of the down payment using his cash reserves, which came to INR 9, 45,000. He approached to different banks to avail a loan for the rest of the 85% which was INR 53, 55,000. One bank offered him the home loan at 10.25% while other offered him 10.15%. Obviously he decided to borrow from the bank which offered him 10.15%. Duration of the home loan was 20 years, and the EMI came to INR 52,210.

At the end of the loan tenure of 20 years, Mr. Varma could have replayed the entire principal amount of INR 53, 55,000 and in addition to that he would have paid a mind-blowing amount of only as the interest of home loan INR 71, 75,453. This means Mr. Varma paid 135% of the total borrowed amount as an interest!

The below table illustrates this:

From the table it is clear that the major component of EMI paid to the bank in the early years of loan repayment is deducted under interest payment. At the end of the 5^th year Mr. Varma would pay an amount of INR 25, 94,942 as interest while the amount paid for Principal amount is only INR 5, 37,671. If he continues to repay the loan over a span of 20 years, then the total amount he repays to the bank is INR 1, 25,30,453.

Let us consider a situation where Mr. Varma has surplus amount with him, then he would have two options:

1.One is he can foreclose the loan by pre-paying the loan amount with his surplus amount. By pre-paying the loan amount he will reduce EMI and can invest the amount saved from EMI into diversified portfolios until he repays the loan.

2.The other option is he can continue with the same EMI and invest his total surplus amount into diversified portfolios.

Let us evaluate the consequences in both scenarios:

Scenario 1:

In this Scenario let us consider that he prepays an amount of INR 5, 00,000 at the end of the 5^th year.  Then his outstanding principal amount INR 48, 17,329 will be reduced to INR 43, 17,328 and EMI of INR 52,510 will be reduced to INR 46,791 where he can save INR 5,419 every month which he invests this amount into diversified portfolios. At the end of the loan tenure he will save an amount INR 22, 64,732 (assuming the rate of return at 10%) from the invested amount. Additionally he will also save money from the interest paid to the bank as by pre-paying INR 5, 00,000 then the interest reduced from INR 71, 75,453 to INR 67, 00,032 where he will save INR 4, 75,420. So, on whole he will save INR 27, 40,152 at the end of the loan tenure.

Scenario 2:

In this Scenario let us consider that he will invest his surplus amount INR 5, 00,000 into diversified portfolios and continue with the same EMI for loan repayment then he will save an amount of INR 20, 88,642 (assuming the rate of return at 10%) which is lesser than the amount he saved in the first scenario.

From the two options, it’s advisable to choose the first option because you will not only save more amounts but also clear the liability. If the loan taken by you is not insured and you prefer to invest your surplus amount into market rather than clearing the existing debt then it might ruin your personal finance If you have cash in hand, it will be prudent to pre-pay the loan as early as possible because it could save you from paying more interest to the bank. Before pre-paying the loan, you need to check with the bank regarding the reviving charges for the loan pre-payment. After pre-paying the loan you can either continue with the initial EMI that you used to pay before loan pre-payment or you can continue with the reduced EMI. In order to close the loan at faster pace it is ideal to continue with the initial EMI, this is advisable to the people who are considering an early retirement.

Home loan payments also attract tax benefits. Under section 80 C of IT act, tax deduction up to INR 1.5 Lakhs can be availed on the principal amount. Under section 24 B, the tax deduction of up to INR 2 Lakhs can be availed on the interest paid for the home loan for a self-occupied home. In case if a loan is availed for a second home or a property which is not self-occupied then the actual interest paid for the year is allowed for deduction under section 24 B. 

Home loan rates depend largely on the prevailing interest rates at which the banks borrow money from the central bank (Repo Rate). When there is a repo rate cut by RBI, then the home loan rate of interest would also go down. This change should be reflected for the existing home loan borrowers, as the EMI amount should reduce. In case the bank not reducing rate of interest, then Re-financing of loan would ensure that the same loan can be transferred to another bank on a lower rate of interest. You can also negotiate with your banker to reduce your rate of interest. But refinancing may consume some charges from the new bank which should also be evaluated before making the re-finance decision.

Conclusion:

Taking a home loan is a long term debt commitment. So, it is advisable to go for a home loan which you can manage with your existing finances Although a lot of efforts are made by the banks to make borrowing lucrative, but care should be taken to understand that there are a lot of hidden costs involved like pre-payment charges, processing charges, foreclosure charges etc. so, it would always be wise to choose a home loan which will not disturb your financial health.

Written By Arthayantra