How you can earn 100% Greater Returns by Investing using a Home Loan

One of the biggest and unfortunate mistakes that today’s investors make is to invest with 100% of their own money and not using a home loan.

Most investors today have a misconception that investing with their own funds (or cash down as some like to call it) is the “smartest way of investing”. Their logic is :

1. Save Interest Expense : By not going for a home loan, they don’t have to incur interest cost. Going by the “a penny saved is a penny earned” philosophy, this means money saved and thus higher returns on investment.
2. Better Price because of 100% Upfront Payment : If the investor has enough own funds to pay entire cost of investment upfront, then he can bargain for a better price with the seller. Once again, money saved via discounts is money earned, which in turn means higher ROI.

BELOW IS WHY & HOW THEY END UP LOSING IN THE LONG RUN

Let’s assume that Mr.X has Rs.30 lakhs cash in his savings account, other investments (such as mutual funds and stocks) worth Rs.20 lakhs and he is also eligible for a loan of Rs.80 lakhs. A top developer launches a new project in which a 2 BHK flat is being sold at Rs.50 lakhs. Mr.X decides to invest as we feel that this property will easily appreciate to Rs.80 lakhs in 2 years time.

There are 2 ways that Mr.X can invest :

1. TRADITIONAL METHOD : Mr.X decides to invests ONLY his available funds, without taking a loan. He uses his entire cash savings of Rs.30 lakhs from his savings account and he also liquidates his mutual funds and shares worth Rs.20 lakhs to come up with a total of Rs.50 lakhs required to buy the flat. Mr.X is happy that he is able to invest with ZERO DEBT and hence thinks he has made the right investment. His parents are proud. And their neighbors too.
2. THE SMARTER METHOD : Instead of using only his own funds, Mr.X decides to leverage his home loan eligibility to make a bigger investment of buying 2 flats of Rs.50 lakhs each.

• He has to make a downpayment of 20% for each flat as the rest 80% can be funded via home loan. Therefore the investment from his pocket is only Rs.20 lakhs (20% down-payment for a Rs.50 lakh flat is Rs.10 lakhs, hence 2 flats x Rs.10 lakhs each = Rs.20 lakhs).
• He takes a loan for the balance amount which is Rs.80 lakhs (Rs.40 lakh loan for each flat x 2 flats = Rs.80 lakhs in total).
• Hence after investing in 2 flats, Mr.X still has Rs.10 lakhs cash left in his savings account and he did not have to liquidate his mutual funds and shares – leaving him Rs.30 lakhs of liquid funds that can be used to make other investments in the future.

PROFITS MADE IN 2 YEARS

After 2 years the property appreciates to Rs.80 lakhs as predicted and hence Mr.X decides to encash his investment and below is the difference in return that he makes :

1. IF INVESTED USING HIS OWN FUNDS – ROI is 60% : As Mr.X made 100% payment from his own funds, he had no other expense and hence his ROI is 60% (Profit Earned is Rs.30 lakhs on an Investment of Rs.50 lakhs, hence ROI = 30/50 = 60%)
2. IF INVESTED USING HOME LOAN – ROI is 160% : As Mr.X has taken a home loan, he has to pay EMIs for 2 years. At an average interest rate of 11%, the EMI works out to Rs.1000 per lakh of loan taken. As he has taken a loan of Rs.80 lakhs, his total EMI per month turns out to Rs.1000 x 80 = Rs.80,000/- per month for both flats put together. In 2 years, he would have paid Rs.80,000 x 24 = Rs.19,20,000 as interest on the loan. As this is paid over a period of 2 years and not as a lumpsum right at the beginning, the real (inflation adjusted) cost of this is only Rs.17,16,000.

Profit : As he has invested in 2 properties, he makes Rs.30 lakhs profit on each one of them, which means a total profit of Rs. 60 lakhs.

Total Investment: His own investment was Rs.20 lakhs initially and Rs.17,16,000 as EMI/interest (calculation shown above), thus taking his total investment to Rs.37,16,000 (i.e. this is what he has put from his pocket in total).

Hence his total returns is Rs.60,00,000/37,16,000 = 160%

BY LEVERAGING HOME LOAN, Mr.X HAS FOLLOWING ADVANTAGES :

1. GREATER ROI : Mr.X has ended up making 100% greater returns even though he has invested lesser from his pocket incase of a home loan.
2. GREATER CORPUS AT THE END : In the first scenario, Mr.X is left with a corpus of Rs.80 lakhs in the end (i.e. what he gets from selling the property) and he has nothing else as he had to liquidate his other investments also to invest in this house.

In second scenario, Mr.X is left with Rs.92.84 lakhs in the end (as explained below).

Hence by investing using a home loan, Mr.X is left with a greater corpus that will continue growing at a faster pace than what could have been possible if Mr.X invested entirely with his own funds.

While this difference of Rs.12.84 lakhs may not seem very significant in the beginning, if you were to repeat this cycle 2 to 3 times in 6 to 8 years, this difference can end up being as large as Rs.60 to 80 lakhs, due to the power of compounding.

1. SURPLUS CASH LEFT : In the first case, Mr.X has no liquid funds left as he used his entire savings to purchase the flat. But in the second scenario, Mr.X used only Rs.20 lakhs out of his initial corpus of Rs.30 lakhs and he also did not liquidate his other investments worth Rs.20 lakhs. If he invested this entire corpus of Rs.30 lakhs in an asset that returned a modest 15% ROI per annum, it would have been worth Rs.40 lakhs in 2 years, further adding to the total return on investment made by Mr.X.
2. TAX SAVINGS ON HOME LOAN : If Mr.X decides to retain the properties, he can also enjoy the tax savings that come with a home loan, which in this case can be as high as Rs.8 to 10 lakhs over time.

How Mr.X Is Left With Rs.92.84 lakhs in Scenario 2 (investing With a Home Loan)

1. (ADD) Proceeds from Sale of 2 Flats at Rs.80 lakhs           = Rs.160 Lakhs
2. (MINUS) Outstanding Home Loan of Rs.40 lakhs per flat = Rs.80 lakhs
3. (MINUS) Interest Cost of Both Loans Together                   = Rs.17.16 Lakhs
4. (ADD) Surplus Uninvested Funds from Initial Corpus        = Rs.10 Lakhs
5. (ADD) Mutual Funds & Shares                                                = Rs.20 Lakhs

Grand Total                                                                            = Rs.92.84 Lakhs

For the above calculation, we have assumed that the mutual funds and equities have not appreciated at all in 2 years. In realty, they would have appreciated by atleast 15% year on year, ending up being worth Rs.40 lakhs at the end of 2 years. If you factor this into above calculation, you end up with a total fund of Rs.1.02 crores!

100% Greater Overall Returns!

By investing smartly and leveraging home loans, Mr.X was able to make higher returns and was able to create 50% greater corpus with the same amount of money.

We are updating our calculator and it will be available in a while. We regret the inconvenience.