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How to manage a home loan if you are worried about job loss?

This article discusses the steps for investors in high-income brackets but hesitant to commit to a home loan due to the fear of job instability.

How to manage a home loan if you are worried about job loss?


Posted on 14 May 2024
Author: Sayan Sircar
10 mins read
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This article discusses the steps for investors in high-income brackets but hesitant to commit to a home loan due to the fear of job instability.

How to manage a home loan if you are worried about job loss?

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What is the issue here?

This post from Social Media got my attention:

Age 35, drawing 3.7L per month. Should I take 1CR home loan ? Very confused and scared if I should take the home loan of 1cr at the age of 35 or not. I will also have to invest 50% of my savings towards purchasing the home. Have a family of 4 dependent on me.

Let us break this down and discuss remediation.

Related:
How does your risk profile change with a home loan?

Income vs. capacity of paying home loans

There is a relationship between house price and monthly in-hand income based on the amount of down payment, the loan terms, and the percentage of monthly income paid as EMI and any existing loans.

As calculated in detail in this article, Home Loan Eligibility for Joint Applicants: how to buy a bigger house, if you make a 50% down-payment and the bank allows a maximum 30% EMI as a percentage of the take-home pay, then the house you can purchase is worth at most 70.4x your monthly in-hand salary.

In the example here, for ₹3.7 lakhs pretax salary, in the new tax regime, the in-hand is around ₹2.8 lakhs/month. The house they can afford, using the 70x multiplier costs almost ₹2 crores.

Since they are paying 50% as a down payment, their EMI, for ₹50 lakhs taken at 9% for 15 years is around ₹50,000/month. This figure is around 18% of the in-hand income.

Therefore, just by buying a much cheaper ₹1 crore house with a 50% down payment, the investor is well within the safety zone offered by their income.

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How about paying off the loan quickly?

There are multiple strategies to pay off a loan quickly:

  • Pay lump sum amounts when bonuses come
  • Increase the EMI every year
  • Start with a higher EMI at the beginning

Pay lump sum amounts when bonuses come

As we have discussed here, What benefit do you get if you make a one-time prepayment to your home loan?, every time you make a prepayment the time left in your home loan reduces since the principal gets repaid.

Time saved when prepayment is done at 9.00% interest rate

In the image above, every time the investor pays off 10%, which in this case is ₹5 lakhs or less, of the outstanding loan balance for a 15-year loan, the tenure reduces by 18.6% or 33 months. So just ploughing the annual bonus into the loan will massively reduce the amount of time left in the loan.

Increase the EMI every year

Time Saved With Step Up Home Loan EMI Vs Home Loan Rate

In the table above, for a 15-year loan, if you step up your EMI by 10% a year, you save 43.42% of the time. So if the investor just increases their EMI by 10% a year, their loan will be paid off in (1-43.42%) * 180 months = 102 months.

We have completed more such calculations here: How much time and interest do you save if you pay off your home loan using a step-up EMI?

As discussed in this post, the final impact on your mutual fund/stock portfolio, if you stop investing to pay off a home loan in 5 years is minimal: What happens to your mutual fund portfolio final value if you choose to buy a house?

Start with a higher EMI at the beginning

What about starting with a higher EMI amount since there is likely room in the monthly budget?

There is always the option of pausing long-term investments and aggressively paying off the EMI from the beginning. Here we will keep the EMI constant which has multiple benefits:

(click to open in a new tab)
EMI Per Lakh Of Outstanding Balance For Below Market Rate Loans

As discussed in this article, How much EMI do I have to pay for my home loan?, doubling the EMI/lakh from ₹1,014 to ₹2,076, for a 9% loan, drops the total loan duration from 15 years to 5 years. Banks, as per RBI directive, cannot charge extra for prepayments from the investor’s own funds.

Related:
Should you prepay your home loan at the beginning or at the end of the tenure?

To understand if now is the right time to take a home loan:

How much to pay from own funds vs. the amount of loan?

To reduce the risk of hardship in case there is a break in income, it is prudent to less as little loan as possible.

Lower the loan, the lower the EMI but higher the impact on the future portfolio

You can choose a higher down payment and end up with a lower EMI by:

You can of course execute any of these options in case your job is actually impacted anytime.

What are the minimum steps needed before the house is purchased?

Do not tell anyone in the office that you have taken a home loan. The reasoning is obvious.

These are the standard prerequisites that must be completed before investing and taking new loans:

For a home loan, it is specifically important to:

  • have a 12-month emergency fund that covers 12 EMIs or more
  • have extra term insurance cover to pay off the loan in case you die
  • have property insurance in case the house burns down or is damaged while the loan is running

Related:
Understanding Insurance Requirements for Home Loans in India: What's Mandatory and What's Optional?

What to do when the loan is already running?

If your loan is already running and if any of the checklist items above are incomplete, please pause your long-term investments (e.g. mutual fund SIPs) to:

  • take additional term insurance and personal accident insurance
  • take the property insurance
  • stock up on your emergency fund using sweep FDs

What to do if a job loss actually happens?

Emergency fund will take care of dependents and EMI

Just because a risk exists, it might become true at some point. You lose your job and are put on notice period. The first order of business at this point will be not to panic. It is easier said than done but it is important to keep a calm head to follow the next steps:

  • Step 1: Any severance pay and full-and-final settlement amount goes into the emergency fund to run the household expenses and pay EMI
  • Step 2: Resist the temptation to pay off part of the home loan immediately from assets like mutual funds or EPF. That can come later in case you cannot find a job for say 6 months or more
  • Step 3: If there are any other loans like personal, credit card or car loans, those should be paid off immediately from other assets.
  • Step 4: If you have been prepaying the EMI regularly, reduce the amount you are paying to your actual EMI and the rest will go into your emergency fund
  • Step 5: If you have an overdraft home loan with a good amount of money parked there, withdraw slowly from there to replenish your emergency fund: How does an overdraft loan like SBI Maxgain work?

In parallel to all of these, you should put in every effort in finding a new job.

What is the right thing to do at the end?

Personal + Finance = Personal Finance

In the end, buying a home is a mix of financial and personal decision-making.

We have covered the financial decision-making here: Goal-based investing: how to purchase your dream home

But the personal part is a leap of faith:

  • your human capital will let you find a new job quickly
  • you have adequate safety nets via insurance and emergency fund
  • the house is going to be the primary residence and not an investment. Real estate investment is for the CoastFIRE stage and not before

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This post titled How to manage a home loan if you are worried about job loss? first appeared on 14 May 2024 at https://arthgyaan.com


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