Let us take a real life case and see what is to be done when you have a lump-sum amount. Should you repay the loan amount or should you Invest that money?

The sad part is YOU need to take a decision TODAY and you will be judged (you may be the judge) after 5, 10 or 20 years!

Facts:

Housing Loan amount: Rs. 36L

EMI 36000 * 20 years (2012 to 2032)

Already paid for 1 year…but the loan amount would obviously not have gone down much…..

Now this person has Rs. 4 L lumpsum. If he were to pay off the lender (Hdfc) what would happen?

It will result in Reduced Installments from 225 installments  to 165.  i.e  60 * 36000 (2027 to 2032 waived off)  – this means about Rs. 19,60,000 of the total amount to be repaid will go down.

Or he could have bought 550 shares of Hdfc Ltd. or 550 shares of Reliance Industries.  Or he could have Invested Rs. 400,000 in say Franklin India Blue Chip. Or Hdfc Prudence. Or Icici Prudential Discovery Fund.

What could have been the result? Difficult to say.

Let us say in 5 years the scenario was as follows:

Hdfc was worth Rs. 8L, Reliance was Rs. 6.4 lakhs, – mutual funds were about Rs. 7 Lakhs each.

Let us assume that ON that date when he offers Rs. 8L to Hdfc, they are willing to drop 72*36000 installments – 6 years installments saved instead of just 5 years.

Actually what has happened is he has saved interest of 10.65% – i.e. he is making an assumption that equity markets (or real estate) will give him a return LESS than 10.65% p.a. for the next 20 years on a CAGR BASIS – or he is NOT capable of earning 10.65%p.a. and hence he is repaying the loan.

People should be calculating their net-worth on a regular basis and seeing whether their NET WORTH is increasing. However the big bad loan figure sits there scaring them, so they want to see the amount reduce / disappear asap.

Now let us see why I would be happy with such a situation:

As a shareholder of Hdfc I should be happy…because the borrower has already paid processing fee for a 20 year loan. The customer has perhaps paid for a 20 year TERM INSURANCE (premium included in the loan amount), …the real beneficiary is Hdfc.

What would have I done? No clue. But the chances are I would have bought 4 shares of Rs. 1L each. Maybe auto ancillaries? Just found scrips with 7% dividend yields. Not bad I should say.