The property that I own is worth 60 lakhs. And the outstanding home loan amount is 20 lakhs. How to include this in my portfolio?
To answer this reader question, we must first understand how paying down a home loan builds an asset, i.e. equity in your home.
The bank gives a home loan to own the property while you use it until you pay back the loan via EMIs. An Equated Monthly Instalment plan (EMI) is a standard way to pay off a loan by making a fixed payment monthly that has both interest and principal in the same amount.
EMI = Principal + Interest
In each EMI, the split of the interest and principal changes since the interest is based on the outstanding loan balance at that point and the rest of the EMI is principal. As the chart shows, the interest part drops off with time, and the rest is the principal. The actual numbers in the chart relate to a ₹50 lakhs home loan taken at 8% for 25 years. The EMI is ₹38,591. The down payment amount is ₹12.5 lakhs.
You can test the numbers using this calculator:
As you pay back the loan, your ownership share in the house will increase in the same way. At the point of taking the loan, you own 20% of the house (12.5 out of 62.5 of which 50 is the loan). The bank owns 80%. As the loan is repaid, you own more and more of the house as the principal is paid off. This is the concept of building equity in an asset. Equity is the part of the asset you own after subtracting the part that the bank owns.
Home equity value = Current home value - Outstanding loan balance
Once you build equity in your home, that has additional benefits:
you can take a top-up loan in case you need money for some other purpose like home improvement, or any other reason
the more you will get to keep if you sell the house
Two approaches to adding a property with a loan to the portfolio
Let’s recap the question:
The property that I own is worth 60 lakhs. And the outstanding home loan amount is 20 lakhs. How to include this in my portfolio?
We can follow one of two approaches here:
include only the equity portion of the property in the portfolio. In this case, it is ₹40 lakhs to be added to the portfolio as an asset
We use the Arthgyaan Goal-based investing calculator to formulate the investment model with all the above assumptions and goals. There is a link to download a pre-filled copy of the Google sheet via the button below.
Important: You must be logged into your Google Account on a laptop/desktop (and not on a phone) to access the sheet.
Once you get your sheet, you can get access to video tutorials in the howto tab.
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Case 1: Include only equity in the asset section
Home equity value = Current home value - Outstanding loan balance
In this example, we will enter the house value minus any outstanding loan amount in the assets table. Here, the investor owns a loan-free plot worth ₹20 lakhs and has ₹40 lakhs equity in the house.
Assets tab:
(click to open in a new tab)
Goals tab:
(click to open in a new tab)
Include the loan as a goal
We will do two things:
add the total market value of the house to the assets
enter the outstanding loan as a liability by entering the EMI payments as financial goals
In our example, we will assume that the house is worth ₹60 lakhs and the outstanding loan is ₹20 lakhs at 9.05% for 10 years. The EMI for this loan is ₹25,000/month or ₹3 lakhs/year.
We will cover two cases:
portfolio asset allocation and SIP amount without the property added
portfolio asset allocation and SIP amount with the property added
The SIP value is ₹113,078/month, of which the ₹45,231 debt SIP includes the EMI of ₹25,000. The assets total is ₹130.44 lakhs, and the term insurance coverage is ₹3.74 crores. Interestingly, the asset allocation uncovers a problem with the portfolio: insufficient equity allocation. The solution here is to divert the entire ₹113,078 (minus the EMI) into equity until the asset allocation corrects itself.
We summarize the results below:
Case 1: Home loan modelled and total house value added in assets: ₹130 lakhs assets, ₹3.74cr insurance needed, EMI included in monthly SIP of ₹113,078, equity required is ₹21 lakhs more
Case 2: Home loan modelled and but no house added in assets: ₹70 lakhs assets, ₹4.34cr insurance needed, EMI included in monthly SIP of ₹137,021, equity required is ₹14 lakhs less
Case 3: No home loan modelled as a goal and equity value added in assets: ₹110 lakhs assets, ₹3.70cr insurance needed, EMI excluded in monthly SIP of ₹111,444, equity required is ₹22 lakhs more
There is a caveat, though, on the asset allocation. We need to ensure that the asset allocation is correct for all the goals in the portfolio. A quick test to ensure this is to check if the target equity allocation of the portfolio is very close to the current one. A too-low current equity allocation carries the risk of long-term goals not being met.
Which one should you choose?
Every investor needs to calculate their home loan and asset exposure for all the three cases described above and choose the approach where:
EMI plus monthly investment is lower
equity allocation is correct, mainly
Property without any loan
If your property does not have a home loan, there are two ways of dealing with the situation:
if you do not live in that house, add the full market value to the assets tab. Ideally you should adjust the amount for the tax and selling costs like brokerage
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This article shows how a very typical salaried couple with one child can invest for future goals using the Arthgyaan goal-based investing tool.
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This post titled How to include your property with a home loan in your portfolio? first appeared on 09 Aug 2023 at https://arthgyaan.com
