What is Home Equity: Introduction, example and overview-1

Home equity is now-a-days becoming quite a common term.
In this article, I’ll attempt to explain it and list the advantages and disadvantages of the home equity.

Home Equity is a concept that originated in the west - for that instance, most of the financial concepts originated in the west. However, home equity has a special significance for the western culture because that fits well into their living and social culture.

What options are available for home buyers?

Imagine yourself as a young salaried individual or a shopkeeper or businessman.
You are working or running your business in a new city, other than your native town, and now you are thinking of buying a house for your own.

One option is to buy the home with your own money - which you may have accumulated from your earnings.
If you don’t have enough money to buy a house on your own, then another option is to take a mortgage or home loan, as most of the individuals do today - committing an EMI repayment for long durations like 115 or 20 or 25 years.

Instead, there can also be a third option, which will also help you in planning your retirement income or pension money - this is the option of home equity.

How does Home Equity Work

You buy a house on loan from a bank, building society or mortgage company. You take this loan while you are working and earning. Say you take a 20 year long home loan when you are 30 years old. Hence, if everything goes well, then at the age of 50, you will finish up repaying all your EMIs and will become the proud owner of your home.

Suppose you have to retire at the age of 58. However, due to your home loan repayment, you were not able to save enough for your retirement. You may have opted for retirement plans like Employee provident fund or private retirement schemes, but at the end you discover that the returns from your retirement schemes are not worth meeting your cost of living after you retire. This may be due to inflation, or bad returns from your retirement scheme or due to dis-savings because of house loan repayments.

So what do you do? You are now the owner of the house. So when you retire, you can use your house to pay for your retirement money.

Continue to Part II of this article

What is Home Equity: Introduction, example and overview-2

This is part II of article What is Home Equity: Introduction, example and overview - 1. Please read this article from part I before continuing with this part

How? That’s where home equity comes into picture.

At 58, when you retire from your job, you approach a home equity finance company like Citibank or Standard Life Property Management. You tell them your situation, your assets (house) and ask them for a home equity plan, which can give you regular monthly income till you die. They visit your house, do an evaluation of the house and then come to a market value of your house. Depending upon this market value, your habits (like smoking), pre-existing diseases, etc., they quote a monthly income to you.

If you accept that offer, then in return you have to sell your house to them, not immediately, but as a “HOUSE EQUITY” - meaning, you sell the house to them as home equity, but retain the possession of your house till you die. Hence, the home equity plan can offer you a very good income at the age when you are no longer able to work. It is called Home Equity,, because like in equity shares, though the shares are sold to the shareholders, the ownership and functioning of the company is retained by the management. Hence, the same concept applies to selling home as equity.
After your death, the home equity company with which you made the contract, will takeover the posession of the house and may rent/sell/lease the house and take monetary advantage.

It all sounds good but the biggest problem with home equity plans is that you cannot leave anything for your family members, once you die. In countries like India, it is quite common to see children becoming rich just by inheriting the parents properties. If the parents decide to go for home equity plans, then the children will not get anything. Even your spouse cannot continue to live in the apartment once you die. He/She too should find something on her own or you must sign the home equity contract jointly, so that even if one of the partners dies, the posession can continue.

The home equity concept is pretty common in western countries, the reason being the social and family life. People like to stay individually, no family commitments, no concept of inheritance of wealth. The concept is “Live today and live for yourself”. It suits well if you believe in that lifestyle.

However, home equity is becoming quite common in India too. The reason is that children now are moving out of their native towns in search of jobs. There has been a major relocation drive. Hence, the parents are now finding it useful to use their property to earn the extra income during the retirement period.

Another issue with home equity plan is that there are not much competition among different firms, as the market is just opening. Hence, people are not getting fair value deals for their house.

The market is still unregulated; hence it’s only between you and the property firm.

Real estate price fluctuation is another major concern.

Another bad news is that people, who are healthy and have maintained a good healthy balanced life throughout their life, will NOT receive good retirement income, because they are expected to live longer. On the other hand, people who smoke, drink and have all kinds of pre-existing diseases will earn more retirement income.
The reason is that the home equity company wants the duration of retirement income payment to be as short as possible. The more diseased a person is, the shorter will be his life span (post retirement) and hence the less no. of monthly payments the property company will have to give him. May be a bit unethical, but that’s how the market works.

Ultimately, by the time you retire, you may see a lot of companies offering this kind of schemes. You never know whether the next generation of kids will be worth inheriting something from their parents, or will our social system (to a certain extent) change such that it may make present day salary earners to go for home equity plans.
Keep watching, markets are developing fast!

Review of Lotus India Agile Fund (Quant Based Fund)

Lotus India Asset Management company has recently launched a so called quant based mutual fund that is aimed at investing in such a fashion that it will eliminate human errors and select the stocks based on a computer generated algorithm.

I liked the punch-line “Eliminate Human Error” and depend upon computer algorithms for stock selection and portfolio churnings.

At last, there is one such fund house that agrees that fund management can contain human errors. Should it mean that other previous funds from Lotus AMC (and other fund houses), are not worth the investor’s trust, as they may be full of human errors?

The fund has the standard rate as per other funds - 2.25% at entry load, 1%, 0.6% and Nil exit load based upon the time you exit after remaining invested in the fund.

As per the details:
Lotus India Asset Management Company Monday launched Quant based scheme, Lotus India AGILE Fund (Alpha Generated from Industry Leaders Fund).

Quant funds operate on the basis of computer generated mathematical models. The investment objective is to generate capital appreciation by investing in a passive portfolio of stocks selected from the industry leaders on the basis of a mathematical model.

The new fund offer priced at Rs 10 per unit.

The fund will invest 90-100 per cent in equity and equity related instruments and 0-10 per cent in debt and money market instruments.

The fund offers two options--Growth and Dividend. The Dividend option offers Dividend Payout and Dividend Re-investment facilities.

Lotus India Agile Fund is an open ended equity scheme that will invest in 11 stocks (9 per cent each) determined by a mathematical model. The portfolio will be reviewed and reset every month.

The fund wants to limit itself to only 11 stocks. Can the algorithm be efficient enough to select the best performing 11 stocks always?

If the fund is so good and (human) error free, then why are there entry and exit loads as any other standard fund? Can the AMC give any guarantee of even 1% returns?

Can a computer really work better in predicting stock prices for the future? Elderly people are now going to cyber-cafes to match the horoscopes of their child with those of their prospective life-partners. All that happens is that crap software like “Kundli” uses stored information and matches the horoscope. Hardly anyone will understand anything, yet the elderly, without having any basic knowledge about a computer, will be happy to use it to match horoscopes.

Even if someone designs an algorithm to predict future stock prices, it all has to be based upon historical data and publicly available market information. Nothing better than a computer matching horoscopes.

No quantitative model can work efficiently ever after to pick up the stock market winners month after month consistently.

This fund is nothing but “Old Wine in a New Bottle”. Same old fund management charges, same old stock selection tricks disguised in the name of quantitative models.

Investors may try their luck by betting!

Pension fund money enters Equity markets

PFRDA, Pension fund Regulatory and Development Authority, has finally paved the way for a new and much awaited pension scheme, through which the pension fund money can now be invested in the share markets, as per the will and wish of the employee.

SBI, UTI and LIC have been appointed as the Fund Managers for this scheme.

However, initially it will be only the central government employee, a bit more than 3 lakhs in numbers, who will have the option of this scheme. It is expected that 20 billion Rs. will be made available to this scheme by June 2008, which is when this scheme will finally be rolled out.

19 states have accepted to implement this policy, except the states of Left controlled states of West Bengal, Tripura and Kerala.

Initially, the government will be bearing the cost of account and fund management charges, which may later be shifted to the individual as things proceed. There is still no certainty about when will the same scheme be made available to the rest of the pension fund holders, (like EPF contributors working for private organizations). So for the time being, such individuals have to depend upon private retirement plans offered by private banks and fund houses.

The move was much awaited, atleast the developments have taken place.

Link to previous article : Investments, Earnings and Living

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.

Investments, Earnings and Living

Some information about a recently conducted survey by Economics Research Department of Indicus Analytics:

India is a land of diversities

The same goes true with the business and economic perspective. As per the research conducted by the Economics Research Department of Indicus Analytics, not a single city in India is having worth of offering all the 3 basic necessities together: Earnings, Investments and Living.

For e.g., Gurgaon near NCR, is good for earning money because of the MNCs available there, but is not worth investing and living due to very-very high cost of living.

Here is the brief summary of the survey:

Cities worth Earning: Gurgaon, Silvasa, Noida, Faridabad, Roopnagar, Chandigarh, Bangalore, Pune, Surat

Cities worth Investment: Silvasa, Coimbatore, Ludhiana, Shimla, Gandhinagar, Surat, Itanagar, Chandigarh

Cities worth Living: Cochin, Kozhikode, Shimla, Thiruvanathapuram, Mysore, Goa, Thrissur, Pondicherry, Konnur, Thiruvallur. Interestingly, 5 cities in this list are from Kerala alone. North India has only one city Shimla. No major IT city is worth living, as per this research - Not even any of the 4 metros in India.

Link to previous article : Buy a home on loan or rent?

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.

Buy a home on loan or rent?-1

This is the question that concerns majority of the people who have relocated to other cities following a job or business requirement - Should I buy the house NOW by taking a loan OR should I wait for some more time for the real estate prices to come down and interest rates to stabilize?

You will find different answers from different people whom you ask this question.

Call up the bank and home loan officer - his response - “We have excellent discounts available, the interest rates are just right to take a loan - in future it may appreciate further. Let me know your details and I’ll visit you and explain”

Call up the realtors selling apartments - their response - “Only 2 flats are left in this building, rest all are booked and this is the most upcoming and happening areas which will only appreciate in value. If you miss it now, it will become costlier day by day and unavailable”

Ask you friend who has already taken a house loan - “You MUST take a house loan as soon as possible. See, I took loan 1 year back. I got the possession 2 months back and the price of my house has increased to 1.5 times in just one year. There can be no better investment than house and house loan. So just go ahead and invest.”

Ask your friend who has NOT taken a house loan and is staying in rented apartment - “Yaar, rented apartment is the best. No long term commitment and freedom to relocate to any place and in any city. God knows how long can I keep up my job.”

Another friend who has bought a piece of land or plot - “Forget about house, a house depreciates in value. Some day or the other the fall will come in real estate. Land only appreciates in value, irrespective of the market situation. So invest in land, and later sell it at much-much higher price to buy apartment.”

Basically, all you will hear is the psychological biases of individuals trying to justify what they have done. Hardly anyone will know anything about the markets - all have taken random shots for their financial commitments and will be ready to shout at the top of their voice to claim that what they did was correct and you should soon follow them by taking their valuable advice.

Now, many-many articles are available on site like rediff, citing extreme end examples of people who should take loans and people who should not take loans. However, a general dilemma can never go away.

Unfortunately, no one can tell what you should do. It is you who has to take the call. It is you who will be responsible for your financial obligations if things go wrong and you get into a financial distress. Hence, take advice from others, but take decisions on your own.

As a finance professional, I know one thing for sure: No markets, No Industry, No country can continue to grow consistently with even a double digit growth. People who claim to make claims of even a mediocre 20% profit from their stock picking skills are again reminded of how the overall market has performed.
Now forget about the stock market and its overall fantastic returns. All of you must have already heard the “Indian Growth Rate ranging from 8% to 10%”. If it is so easy to make money, why is the government, the country still struggling to keep up the growth rate at mere 9% (not even touching the smallest double digit figure of 10%)?

The reason is same as cited above. Overall, the profits from one segment are nullified (to a major extent) by the losses in another segment. A high salary requires relocation, and the cost of living eats up majority of salary. If you can make and save more - you are just lucky.

So coming back to the real estate market - there has to be a saturation level -atleast in terms of the price rise. If today, the house prices are rising with annual 20-50% range, then there will definitely be a time when the prices will either fall nosedive, if the MNC start laying off people (the major customers of real-estate boom) OR atleast there will be a time when the price rise will be limited in a single digit range. When will it happen? No one knows. But my finance knowledge and historical data is sufficient to convince me for this.

Continue to Part II

Buy a home on loan or rent?-2

This is part II of the article Buy a home on loan or rent?. Please read the first part before proceeding with this one

So unfortunately, the dilemma continues. But just take an example as cited in my previous article. You decide to buy a flat costing 40 lakhs. You get 32 lakhs as loan from the bank. Rest 8 lakhs you put in from your own kitty. The EMI typically comes to around 30,000 per month for 20 years. So for 32 lakhs loan, you return to the bank an amount = 30 K * 12 months * 20 years = 72 lakhs.

This amount is double the amount of money you are taking from the bank as house loan

Off course this has to be repayed over a long duration of 20 years so DCF analysis will lead to a lower amount, but this figure tells you the cost of loan. But is it really worth taking a loan when the bank is earning more than double the amount from you? More so, in the world which is full of uncertainties - about your job, your salary and everything else?

Also, don’t forget that 8 lakhs you are paying from your pocket. Ultimately, if everything goes well for 20 long years - one fine day you will become the real proud owner of your house, maybe when you reach in your forties or approaching 50. During these 20 years, you would have lived with either of the two:
• A bit worried look about job and salary uncertainty - due to your home loan commitment OR
• An ignorant belief and worry less life if you want to keep yourself ignorant about your home loan & your uncertainties

To me, majority of (sane) persons would be forced to live with option 1. Add to it the increase in cost of living due to marriage, kids, their education, elderly parents (their medical care) and so on, and things will keep looking difficult (may not be difficult in reality, but due to the commitments).

Ultimately, it all depends upon the individual - how he takes it. People will have all kinds of flashy words & phrases - “Positive outlook towards life”, “Taking up the Challenge”, “Doing something on my own” and so on, the fact is that in case of a financial distress (if it occurs), you will be left all alone. The same friends who advice you will no longer be willing to see you and you will have to face the situation on your own.

Take a step forward:
Instead of taking the house on loan now, go for a rented one for a period of say 10 years. In an IT city like Hyderabad, a typical 2 BHK flat would cost 8 to 10 K per month. Assume that you start with 9K and your house rent increase each year by 10%. So overall, during these 10 years, you would pay to different house-owners a total of 17.2 lakh Rs. (Round it to 18 Laks)

On the other hand, during the same 10 year period, if you had taken a housing loan, you would have repaid to the bank half of 72 lakhs - i.e. 36 lakhs and 8 lakhs upfront from your kitty = total 44 lakhs. Of course you would have become part owner of your house in this case.

So, in case of renting the apartment, you save 44 - 18 = 26 Lakhs as compared to buying one on loan.

Even if the real-estate prices keep on increasing at a rate of 8% each year, the house costing 40 lakhs today will cost 80 lakhs after 10 years.

So think about buying the house then. Will it be a better option? Let’s see:

• During these 10 years - you’ve lived freely - no commitment - no worries
• If you loose your job, you pack up your bags and go back to your native town.
• If you are still able to keep up your job for 10 years - that means you are worth it. However low, you can still expect atleast a 5% salary hike each year. That will add to your accumulated savings, which will severely reduce your loan amount.
• You can take decision on “Take things as they come” basis
• Your rent savings will be more, if instead of paying an increased rent, you opt to move to another apartment of same rent or low rent.
• You don’t have to worry about any kinds of problems that may be linked to a house purchase and its later consequences as mentioned about the risks with a house purchase in this article
• If the reality markets go for a correction, you will have the option of buying the similar flats with cheaper price levels - anytime during the 10 year period - meaning more savings in future than present day high price purchase
• In the 10 year period, you may move around 3 time to 3 different houses. It’s not that difficult to find a house on rent

Nothing in this world comes without risks and compromises:
• You will have to keep moving to other apartments if the rented house or house owner is not good (Independence for some, problems for others)
• You will have to think carefully about your family (if married) and plan your family developments
• People usually do not appreciate a family man living in rented apartments for long. One may have to face it. However, the benefits of postponing the purchase can be a major beneficiary

Ultimately, the choice is yours. You have to fight against the variations in the markets. You have to take the decisions on till when to rent and when to buy. If buying then is the market really low or can it go down further.

I may have missed some points in the calculations above. Some assumptions may be faulty. However, the essence that I want to convey is that just don’t forget that loan is very-very costly. Avoid it as much as possible. The mental tension that one gets once he’s in debt cannot be explained. His negotiation power reduces, he cannot switch job and move to another city easily, he starts worrying about the job, its’ security, the family, kids and very simple liabilities add up.

Hence, take the minimum possible loan. Live a happy and stress free life. Use your own money. Leave the OPM concept to banks and brokers (OPM - Other people’s money -like the business of MF managers, brokers, etc.) OPM is not for people without financial background.

Remortgaging: Moving to another home loan plan-1

As some of my colleagues are trapped in with floating rate home loan, I’m sure some of you may have had similar experiences.

In my previous article on house loan: fixed v/s floating, it appeared as if the readers have got the impression that I am for fixed home loan only. It’s not the case. As rmathew and nickp2 have rightly pointed out in the comments on my previous post, , that even if the interest rates are lower and you take fixed rate home loan, there is no such guarantee that the bank will not change the rates later. There may be a clause in the loan agreement, even with fixed interest rates, that banks may raise the fixed interest rates if the market situations change drastically. So ultimately, the loan borrower is in a fix, either this way or that way.

Take this practical situation:
Let’s say the loan are available for cheap i.e. the interest rates are low. A fixed rate home loan is available for 7% while a floating rate home loan is available at 6.5%. Why is fixed rate 0.5% higher than floating? The reason is that in fixed rate, the risk, to a certain extent, is passed on to the bank. In case of floating home loan, even with the slightest of rate changes, the bank will immediately change the rate for the floating rate borrower. But for fixed rate borrowers, they usually do it when there is a significant change in the interest rates. Like 7% in 2003 and now 12% in 2007. Hence, when one takes fixed rate home loan, he has to pay for the risk - ultimately, the bank is passing on the risk to the customer of fixed rate loan, by charging a higher interest rate as compared to the floating rate loan.

To understand it clearly, have a look at the interest rate offered on fixed deposits of one of the Indian banks:




Interest Rate on Deposits Below Rs 15 lakhs

7 days to 14 days


15 days to 45 days


46 days to 60 days


61 days to less than 3 months


3 months to less than 4 months


4 months to less than 6 months


6 months to less than 9 months


9 months to less than 1 year


1 year to less than 2 years


2 year to less than 3 years


3 Years to less than 5 years


5 Years upto 10 years


In general, people believe that the longer the duration of your deposited money, the better interest rates will be offered by the bank. It is true to a certain extent, because the longer the duration of your deposit, the more time your money lies with the bank, the more time bank will have to use your money and earn profit and hence it can offer you more percentage returns in terms of higher interest rates.

However, banks cannot simply keep on giving higher interest rates depending upon the length of the deposit duration. The reason is that banks are also taking a risk by promising you a return. Suppose today, the banks promise you 12% return on 5 year long deposit and you deposit 1 million with the bank. However, in the 3rd year, the interest rate fall to the level of mere 4%, then the bank will be at a big loss if it continues to give you 12% returns. Hence, the banks have to cover this risk.

Have a look at the table above. As it can be seen, starting from 7 days to 1 year deposit period, the bank interest rates are growing consistently - from 0% to 9.5%. However, from 2 year it again starts to dip. For 2 years it is 9%, while for more it is down to 8%. This is a practical example of how the banks limit their long term interest rate risks.

Though difficult, to a certain extent it is possible to define certain ranges for interest rates for upto a year, as interest rates do not change everyday (like stock prices do). But forecasting beyond that, it becomes difficult. Hence, the interest rates offered for long term than 1 year is low compared to what is offered for upto 1 year.

Continue to Part II

Remortgaging: Moving to another home loan plan-2

This is part II of the article Remortgaging: Moving to another home loan plan. Please read the first part before proceeding with this one

In case of home loan fixed or floating, the banks have to deal with this interest rate variation for a much longer duration - 15, 20 25 years. This becomes a major risk for them as the amount of money at stake is also high. Therefore, when one takes a floating home loan from a bank, initially he is shown the juicy carrot of 0.5% lower interest rates than fixed and then he is ripped off his money by increasing the floating rates as soon as RBI changes rates but not reducing it when the RBI cuts the rates.

This way or that way, fixed or floating, the banks win at all fronts. The financial planning of the individuals may or may not fail - because he becomes the victim of rates variations - a victim of randomness.

But do banks simply keep on charging anything they like in the name of floating rate? No, they don’t, because the market is efficient. Suppose that you started repaying a floating home loan with 10% interest rate. But after 2 years, the bank gradually increased it to 14% owing to the market changes. However, it is offering a discount to the new customers, who are offered loans at 13.5%. What do you do?

The fact is that banks cannot simply keep on raising the interest rates as they wish. Because there is competition from other banks in the market and if rates are increased to a high level, then the customer may go for what is called Remortgaging - meaning, financing the present loan which is costing him 14%, with another bank which is offering say 13% to new customers. Hence, if you took a loan of 3 million and have an outstanding of 2.5 million, then you can save 1% by remortgaging, i.e. 1% of 25 lakhs = 25K each year. The compounded value of this 25K will be much higher.

Banks know this fact very well, hence they do not increase the floating rates randomly as per their will and wish. However, they still have a mechanism to extract money from you. If you remortgage, there are pre-payment charges typically 2%. Hence, If you are remortgaging to save the 1% (or 25K each year), then upfront you will have to pay 2% to your existing bank which will be 2% of 25 Lakhs = 50 K. Then there will be other formalities like stamp duty on new agreement, insurance of home to new bank as beneficiary (or transfer of benefit), your personal insurance, etc., etc. Ultimately, it all becomes almost null and void.

If you are getting fed up of your present bank which was good to you in the beginning and now charging you higher interest rates for EMIs, what is the guarantee that the new bank will not do the same to you after sometime?

Hence, think 10 times before selecting a plan or a loan. Be it a small personal loan or two-wheeler loan or a big long term commitment like housing loan. It is not at all advisable to be in debt irrespective of whether the interest rates are high or low - unless and until you are using the loan money for further profits. Don’t forget that this is India, where the bureaucratic system is hopeless. A complain in the consumer court takes years to resolve. House is a necessity, one needs it. But don’t base your judgement on faulty assumptions of your salary - its eternal growth and its eternal continuity.

I will agree with only 1 point mentioned in the book Billionaire in Training by Bradley J Sugars, however

A paycheck, no matter how big, cannot be defined as wealth or riches. So often people seem to mistake getting a bigger paycheck or salary for getting richer.

The biggest thing with a paycheck is that it might stop anytime, you never know, as this cute little puppy discovered after the big deal :-)

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

Cost of loan (House Loan)-1

Andy has left a link to a house loan and “getting rich” article (half cooked) in the comments on my previous post on house loans. Here is the link to the article on rediff.

Now the biggest problem with these kind of HALF_COOKED and useless articles on rediff is that they not only misguide the readers, but also prompt them to buy the books by putting up half the information. Like the title of last part of the article is “Lies, Lies and More Lies” and then it says “This has got to be one of the most insane pieces of advice I have ever come across.”, but it hardly tells anything about why this is insane from the point of view of the author. The only aim of this article is to create curiosity about the book, so that people can buy it. Even the price and publishing house is quoted at the bottom. This is one reason I really hate rediff - half cooked, incomplete, marketing articles, leading to indirectly misguide the common readers.

Now my knowledge tells me that taking loan is perfect - use other people’s money and generate income for yourself.

So, Debt is good - but only sometimes.

Let’s take an example.
I am running a shop. I need money to buy goods at wholesale price and then sell them off at retail price to earn money.

To get the money from a bank as a loan, I need to get into lot of formalities - Income tax returns, insurance, stamp duty, etc. So what I do is take the money from market. There are still many lenders (Sahukaars), who are offering loans (though maybe illegal) to individuals in open market. The simple terms and conditions for loans are individual relations and reputation. The loan is offered on simple terms. X gives 100,000 to Y as a loan, and Y has to give back 1.5% each month as interest. Whenever Y has sufficient money, he returns the entire 1 Lakh and the loan ends. If Y has part money like 50,000 he returns that and interest of 1.5% is given only on remaining 50,000 of loan. The income to the lender is the interest of 1.5% that he gets each month. No insurance, no documents required. Simple and straightforward.

This is what goes on in local markets and retail businesses in towns and cities. I’m not sure if this lending business is legal.

Let’s take an example. I need 60,000 to start my shop. I have good reputation and relations with a neighbouring person who is willing to lend me money for 1.5% per month. I take 60K from him and start paying him 1.5% * 60K = 900 Rs. to him each month. This goes on for 1 year. After 1 year, I have generated 40K and I repay that money to my lender. Hence, from that month onwards, I pay an interest only on remaining 20,000, i.e. 20K * 1.5% = 300 Rs. At the end of 6 months, I repay him the remaining 20K, and my loan ends.

So the lender received a total of 900 *12 months + 300 *6 months = 12,600 Rs. as interest over the 18 months duration.

Continue to Part II

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.

Job security and financial matters

An interesting email forward I received :-)

Never love your company, love your job,
you never know when your company stops loving you.

Taken from Hutch sold to Vodafone!

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

Home loans: Fixed or Floating Interest Rates? - I

It’s time that you may have decided to take a home loan. You have a well paid job or business and you know that it is reliable enough to last for many-many years. You can repay the EMI of you home loan during the entire duration of the home loan. So fundamentally, you are prepared and convinced that everything will work well and in your favour.

However, the biggest dilemma that faces each individual seeking house loan is whether to go for fixed interest rate home loan or floating interest rate home loan.

In this article, I’ll try to highlight some fine details that one must keep in mind.

Let me begin with the basics (as I do always).

You decide to buy a house. The builder quotes an amount; say 4 million or 40 lakhs. You approach a bank like ICICI or HDFC that offers you home loan. The bank says that they can offer a percentage of amount as housing loan - say 80%. Therefore, the bank will give you loan of 80% * 4 million = 3.2 million or 32 lakhs. The remaining 8 lakhs you will have to put in from your own pocket. Suppose that your loan tenure is 20 years.

This 3.2 million money worth of house loan will be available to you in 2 options - either select fixed interest rate loan or floating interest rate loan.

If you select FIXED: the bank quotes a FIXED amount that you will have to repay to the bank each month, for the entire loan duration of 20 years. So suppose that interest rates for FIXED home loan scheme are presently at x%, and the bank calculates your EMI or Equated Monthly Installments at an amount of 30,000 per month, that will mean that you will have to repay 30,000 each month to the bank for 20 years. In this case, you will repay a total of 30,000 * 12 months * 20 years = 72 lakhs or 7.2 million

If you select FLOATING: the bank will NOT quote a FIXED AMOUNT, but a VARIABLE interest rate to begin with. The initial interest rate that a bank may quote, for example, may be 13%. Hence, your initial EMI that can be quoted by the bank (based upon the 13% interest rate) can be 28,000. But remember, this is the initial and variable figure. It can change at a later stage - (that’s what is happening with most of the loan borrowers.

Continue to Part II

Home loans: Fixed or Floating Interest Rates? - II

This is part II of the article Home loans: Fixed or Floating Interest Rates? - I. Please read the first part before proceeding with this one

Hence, the case of FIXED RATE home loan is simple and straightforward. You take x amount of money from the bank as house loan. The bank calculates your EMI based upon the then prevailing FIXED home loan interest rate and tell you how much you will be required to repay each month, for the entire duration of loan.

The problem comes with floating rate home loan, where things become ugly and unpredictable. Remember, banks offering home loans are not charitable organizations working on humanity basis - they are business organizations running for profit, and most of the loans market is dominated by private players like ICICI and HDFC banks.

Why do people take fixed rate home loans
People take fixed home loans when the interest rates are low. For example, during the 2002-2004 period, the fixed home loan rates came down to 7.5%, hence, many individuals took fixed rate home loans. Today, bank FD’s are offering as high as 9.5% returns, which is much higher than the interest these people are paying on their hme loans. Another benefit is that the borrower knows the exact amount of money he has to repay each month - so no unpredictability.

Why do people take floating rate home loans when it is unpredictable?
People take floating rate home loans when the interest rates are high - like the present situation, where the interest rates are hovering in the range of 11% to 14%. What people believe is that IF the interest rates fall, then their EMI amount will go down and hence they will benefit because they will have to repay less money to the bank. However, there is no such guarantee that the interest rates will reduce. Even if they do so, the banks may or may not reduce the home loan rates, hence, the individual will end up paying the same EMI amount.
Instead the rate may increase further and then the banks will immediately jump and increase the EMI repayment, because that will mean more profit to the bank and loss to the individual loan borrower.

How do the bank decide how and when to increase the floating rate interest?
This is the tricky part and most of the individuals get trapped in this. When you take a loan, you are asked to sign numerous times on a THICK booklet of loan agreement. The language, the conditions and other terms mentioned in this booklet - no one bothers to read it. All of us blindly sign it taking things for granted. Even if you read it, you don’t have any choice, you have to accept the T&C; to take the loan. However, in essence, everything mentioned in the agreement is in favour of the bank.

Banks have something called a PLR or Prime Lending Rate. This is completely at the banks judgement. So it is possible that SBI may be having a PLR of 11% today, while ICICI may be having a PLR of 12%, while HDFC may be having PLR of 12.5%.
All the loans offered by banks are based upon this PLR. So, a two-wheeler loan offered by ICICI bank may be quoted as (PLR + 3%), which means it is available at 15%, while education loan may be offered at (PLR + 2%) = 14%.
On the other hand, SBI having a PLR of 11%, may be offering two-wheeler loan at (PLR + 2.5%) = 13.5%, while education loan for (PLR + 3.5%) = 14.5%

In summary, each bank maintains its own PLR (which can change anytime), and each bank determines different loan rates for different purposes based upon their PLR, by adding a figure to it (which again can change anytime at the discretion of the bank). So it is possible that you go to SBI to take education loan today and you are quoted 14.5%, and if you again go to the same bank after 15 days, you may be quoted 15%, because either the PLR may have changed or the additional figure may have changed in 15 days time.

Continue to Part III

Home loans: Fixed or Floating Interest Rates? - III

This is part III of the article Home loans: Fixed or Floating Interest Rates? - I. Please read the first part before proceeding with this one

How does bank determine PLR
Banks have to follow certain policies and rules set by RBI and maintain somethings like CRR, etc. I’m not gonna take you into the complexities of CRR, etc, but the important thing to note is that RBI rules are the once that force the banks to change their PLR.

The case of home loan (floating) is hurt by this PLR mechanism. Since bank has the sole decision making power, it can anytime increase (and seldom reduce) your floating home loan rates. If the RBI increases the rates for all the banks, the banks immediately change their PLRs and hence the floating rate repayment amount increases. But if the RBI reduces the rates, though it is a relief for the banks, the banks may NOT necessarily reduce the EMI amount for floating rate loan borrowers. The reason, banks reduce their PLRs after the rate cut by RBI, but increase the addition % factor that keeps the floating rate same for existing customers. Banks win on all the fronts - the individual looses out.

Though the market competition forces banks to keep rates competitive, but ultimately, the individual has to pay the price. The most recent example was observed during Dussehera- Diwali festival. Most of the banks reduced their home loans floating interest rates - many colleagues in my office were happy and waiting for a letter from the bank thinking that their floating rate EMI will reduce. But it did not happen. None of the loan repayers got respite or reduction in their EMI amounts. The reason - banks had lowered the interest rates only for NEW CUSTOMERS. For the existing customers, the rates remained the same.

Loan Borrower’s Dilemma
When the rates are high - the biggest dilemma is whether the rates will fall or rise. Durations like 20 years is a long time. Interest rates can vary anywhere from 2% to 25%. What can an individual do? Fixed or floating? And secondly, what exactly is high? Is it 10% or high means 15%? No one knows.

When the interest rates are low - That is the best time to take a FIXED home loan. The lowest rates in India have been in the range 6 to 7.5% in 2002 to 2004, yet individuals took floating rates home loan, believing that interest rates may fall further. Today, the same individuals are repaying double the initial EMI amount, as their effective floating rate has reached 12% or more.

Ultimately, it’s the uncertainty that you have to fight against. Remember, everything in the agreement is in favour of the bank. There is no such thing like if you take floating rate, then your EMI will go down if RBI reduces rates. It’s all a messed up business, and we individuals without any knowledge of finance become victims of it. There are no choices; people need a house to stay once they want to settle down. Just assess your cash inflows and certainty about them during the duration of loan and act accordingly.

Link to previous article Investing in Airline Companies?

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.

Investing in Airline Companies

Virgin Altantic is on its way to make an entry into the Indian Skies.

The owner, Sir Richard, who is here in India, have clearly stated that he wants to fly his Virgin Atlantic planes on the internal Indian routes and serve the indian masses. Not only that, he has a strategic tie up with an Indian company, which is bidding for telecom spectrum to enter the telecom and mobile services in India.

He is even intending to start his A380 large airliner services from Indian Airports.

In my previous article Effect of MnA on stock prices, I've mentioned about the case of foreign players entering the Indian internal routes and endangering the Indian airline companies. Seems like the cookie is about to crumble.

Though Richard complained about the bureaucratic framework and long delays in getting the requierd permissions from the government, his open declaration about the intention of entering into the indian internal skies have started sending jitters to indian players. No wonder if the government someday allows the foreign players like Virgin Atlantic to fly on Indian routes. May be 1 year, 2 years or 5 yearas down the line, but someday it is bound to happen. Investors in Airline companies like Jet Airways and Air Deccan, please remain cautious.

Richard Brosnan and Vijay Mallaya are considered to be like headed businessmen - Lavish, Show-off and ready to take the business bull by its horns. Hope to see more players entering the frame and making life comfortable for the Indian passengers.

Link to previous article: Financial and stock market failures

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.

Financial and stock market failures

Sukumar has left a link to a very nice and eye-opening article on my previous post .

Though a bit lengthy, this article is a MUST READ for every individual. It talks about how individuals, financial organizations and sometimes even governments make a mess of the economical and financial systems, (or are forced to make a mess of the economical and financial systems).

The main excerpt that I think is the most important part of the article is as below:

In 2000, America faced a recession. But rather than letting the economy rebalance, the Federal Reserve decided to slash interest rates to artificially stimulate the economy—even though it knew that doing so would probably create even bigger problems later.

Consequently, mortgage rates in America plummeted and, suddenly, millions more Americans could buy homes. House prices skyrocketed: tripling and quadrupling in many areas. The bubble fed on itself as prospective homeowners, often acting more like speculators, rushed to buy homes as quickly as possible to capitalize on further price appreciation.

As home values rose, fewer people could afford traditional loans. To keep their profits growing, banks and lenders began offering easy-to-get subprime mortgages—mortgages to borrowers normally considered too risky due to credit history, income status and other factors.

Oftentimes these loans were adjustable-rate, or had initial teaser rates that would ratchet up later. Often the loans were given without any applicant background checks at all. As long as a borrower could write his own name and yearly income (regardless of whether or not it was true), he could get a loan.

And everyone was happy. Record house prices fueled a building boom and jobs were created. Borrowers were glad because they got huge loans and could purchase homes that were rising in value. Real-estate agents were pleased because the bigger the house sold, the bigger their profit. Lenders and loan brokers were cheerful too because they each got their cut of the action.

But there was just one problem: The whole boom was based on artificially low interest rates. What would happen when interest rates rose, homes stopped appreciating and borrowers had more difficulty making payments?

Here is the link to the entire article

Thanks Sukumar

Link to previous article: Changes in the index and effect of changes in index stocks

Off from the market :)

I'm enjoying Diwali Leaves and will be off with the usual blogging for the next 2 days.

Enjoy the previous articles, if you've missed any!

Wishing you all a Happy and Propserous festival of lights!

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