How to reduce your loan tenure and save money by opting for a Systematic Investment Plan (SIP)?
You must be wondering how can one possibly do this, right? Let’s understand this using an example.
Student loan required: Rs. 25 lakhs
Interest rate: 7%
Loan tenure available: 20 years and 25 years
EMI for 20 years: Rs. 19,382/-
EMI for 25 years: Rs. 17,670/-
Return on equity mutual funds: 15% (Assumed)
If you opted for the 20-year SIP, you would pay the required EMI or Rs. 19,382/- However, if you opted for the 25-year SIP, you would end up saving Rs. 1,712/- every month.
In this case, you should ideally opt for an EMI of 25 years and start a SIP of Rs. 1,712/- per month (EMI savings from taking a more prolonged loan). Technically, it’s similar to opting for the 20 years EMI because your cash outflow is the same, i.e. Rs. 19,382/-
However, as you started, a SIP of Rs. 1,712/-, you would be able to pay for the loan in precisely 16 years and 2 months. The future value of your investments after 16 years and 2 months would be approximately Rs. 13.90 lakhs, which is equal to the value of the loan outstanding after 16 years and 2 months.*
You are effectively clearing your loan 8 years and 10 months earlier by doing this.
So next time, when you’re planning to take any loan, try to take a loan of higher tenure and invest the differential amount in an equity-based mutual fund. However, this will only apply to mentally and financially prepared to pay the EMI’s of the higher and lower tenure. Also, for such cases, ideally, you should be opting for a balanced mutual fund to reduce the risk aspect of your portfolio.
*All the calculations were done on MS Excel.
Note: The interest rate, equity-based mutual fund return and tenure were assumptions, which may vary. Please seek help from your financial advisor before making such investment related decisions.