Cost of loan (House Loan)- 2: Finance Trading Times

Cost of loan (House Loan)- 2

This is part II of the article Home loan v/s other loans. Please read the first part before proceeding with this one


What is more important for me is the cost of loan. I am paying the lender 1.5% each month. If, and only if, I can make more money than this 1.5%, then the loan is worth taking. To be on the justified side, I have to make atleast 3% return on the loan amount each month – because out of this 3%, 1.5% will go to the lender and I will have the remaining 1.5% (atleast). If I am not able to make even 1.5% for myself, then it will be stupid for me to take a loan, because I will be paying more to the lender than what I am making.

People who take loans for trading should understand this thing very well. To justify your loans, you MUST make atleast what you are repaying as interest to the lender i.e. total should be atleast DOUBLE the interest you repay.

The same can be extended to trading activities with the broker. Your individual profit on your trades should be atleast equal to the total commission you pay on the BUY and SELL legs of your trade. If you don’t make DOUBLE the commission as profit, that means your broker is earning more than you for your trading activities.

I prefer taking this kind of loan from the open market, though I have not taken anything till now, and I don’t know what reputation I have – because I have never stayed at one single place for long time during my career and never run any visible business to let others know my potential and credibility (if any).
This kind of open loan is also preferred because I don’t have to pay any stamp duty or buy insurance. That risk is bourn by the lender.

So coming to the debt part, just keep in mind to take the loan ONLY if you can make more than what you repay.

The case of house loan is completely different. You can justify your returns on a loan if it is taken for business or trading activities, because it generates a measurable return. But a house loan is not for generating returns, hence you cannot measure any returns on it. All you have to do is fulfill a necessity of taking a house for staying in it.
You may measure the returns on your house loan if you are taking it as a SECOND investment, purely from the point of view of selling/renting it later. However, with the current situation and sky-rocketing prices in the real estate sector, there are hardly few people who are willing to look for a high priced house as an investment.

Let’s take an example. You buy a 3 BHK house on loan for 4 million (40 lakhs). The EMI comes to 30 K per month. Since this is your second investment, the best way to generate income is to rent it. But even in a costly metro like Mumbai or Bangalore, how much rent can you expect - 10K, 15K, 20K, or maximum 25K for your 3 BHK flat? Hence you are on the loosing side (atleast till the duration of your house loan repayment). Even if you manage to find someone who is paying 30K or 35K as rent to you, then you must not forget that this rent will become taxable income for you. So the net you receive with 30% tax bracket, is 70% * 30K = 21,000. This is still way less than your EMI. So, unless you are sure and certain about horizon of more than 20 years loan period, it will be foolish to go for house as second investment.

I’m not sure what was covered in the book (Billionaire in Training by Bradley J Sugars.) mentioned on rediff article. I’m not even interested in reading it – because I know that MARKETS ARE EFFICIENT. If it was so easy to become a billionaire just by reading a book that merely cost 299 Rs., everyone would simply follow the book and become a billionaire. May be that some parts of the books are relevant, but it is a well known fact that money comes from money – means you need money to grow your money.

Keep looking around. The world is full of all kinds of examples and case studies.

Thanks Andy for the link to the Article!

Link to previous article : Home loans: Fixed or Floating Interest Rates?


Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.

You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
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6 Comments: Post your Comments

Andy K said...(on 22 November 2007 at 22:32 )  

Hi Shobhit,
Thanks for your reply through a nice article. So in line with my question about 20% part of the loan we pay as our contribution, i want to share my experiment, I booked a flat for Rs 1.7 million for which i approached t various banks in the market, no bank was ready to lend me more than 85% of my loan i.e. not more than 1,445,000 so my contribution was 15%, around 255,000. after searching for quite a while i approached a new bank which was a new player in the Homeloan market, and i managed to bargain a good deal of 93%, i had to put only 7% of 1.7M here i managed to save 8% of my contribution which was around 1.36 lacs..as i told you i took 2 lacs personal loan from private bank with 8.5% per annum flat rate (15% monthly reducing) and i invested total 3.36 lacs in the market same time i started paying the home loan. to my surprise, despite of volatility in mkts and recent great fall, in last 6 months, i have recovered all my contribution(7%) to the home loan as well as some part of my personal loan. The tenure of personal loan is 4 years, and home loan is 20 years.
Here i started with recovering my contribution to the homeloan from investing in market. now my next goal is to generate enough money which will fetch me my monthly EMI if 15k. I am just experimenting this all with my money and risk. I know all the market risks and i want to play safe with considering all the market risks..
Would you please comment on this?

What prompted me to do this is when i will finish my homeloan in 20th year, i would have paid 4 millions to the bank for 1.7 million home. so i want to reduce that huge burden right from the first day..

Thanks again for your good reply.
Aniruddha

Anonymous said...(on 24 November 2007 at 05:02 )  

My query is:

whether to go for home loan float/fixed or buy a home without loan may be after 10 yrs. Till that continue accumulating the wealth.

Jayaprabhakar said...(on 25 November 2007 at 21:30 )  

Hi,
I have been following your articles for a long time. I have read all your posts in this blog and your posts are really great. Congrats.

I have some comments for this post.

So the net you receive with 30% tax bracket, is 70% * 30K = 21,000.
1. You have to consider the tax benefit for the interest you pay for the home loan. (You can ignore the 80C part of home loan, as the 1 lakh limit is too less and will be covered with the PF, Life Insurance, Mediclaim, etc, and the tax law may change to remove this benefit. But the interest paid for home loan can't be changed, especially for a rented property)
2. You can avail the standard deduction of 30% from the rent you receive.
3. I haven't read the book, neither do I believe on such books. But, just want to remind you that this book is written for US, where the interest rate is lower, and typical home loan terms are 30 years or 35 years (I have heard that banks even give 40 years loan), and the rents are higher. I have heard that the rent you receive will be very close to the EMI we pay. This is not the case right now in India. Although a couple of recession and inflation in next few years can make our market as good as US, this is not the case right now.

Investment n Trading Advisor said...(on 25 November 2007 at 23:20 )  

Andy,

here is the response to your queries:
1) Money is made by trading only in volatile markets. If the markets are not volatile, then the traders have a problem. So it's good that your trading activities have been in line with the market volatilities.
2)You can have goals, but there is no certainty in the market about returns. It all works randomly. If you have learnt to trade and cut your losses and book profits, then you can go ahead and carry on with your trading activities. No one can guarantee anything. It all depends upon you.
3) As you are right, that you have big burden now- The loan is not at all advisable. Get rid of it as soon as possible, before carrying on trading - if you really wanna play safe. Rest is upto you. :-)

4) Dont believe that getting 93% loan by a new bank is good for you. A loan is a loan, and it comes at a big cost.

Thanks,

Investment n Trading Advisor said...(on 25 November 2007 at 23:23 )  

Anonymous,

My personal advise to all is that never take a loan. For Home loan, there is a big tradeoff - if you dont buy it now, you may have to buy something later at really outside the city limits. Secondly, the prices may shootup further (they may comedown as well). It all depends upon market condition.

If you ask my frank advise, ONE should NEVER buy a house unless he has the capability and money to finance atleast 50% of it. The smaller the loan, the better.
Keep accumulating money and buy the house when you have atleast 50% of total price to buy

Investment n Trading Advisor said...(on 25 November 2007 at 23:27 )  

Jayaprabhakar,

Thanks for the kind words.

1)If you have the credibility of taking a loan upto 30 lakhs, that means you have a hefty salary - otherwise the banks will not give you that much loan. Hence, the tax benefit goes awa with it because you cannot exceed the 1 lakh limit. Also, it is the interest part that is tax exempt

2)The same applies to standard deduction

3) Even if the interest rate is lower in US, there also the markets are efficient. I dont think the book has been written for specific period of low interest rates. No one can be sure how long this situtation in India or US will continue.

Thanks,

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

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