How to build a fence of financial security

If you have taken a huge home loan, here are some lessons from the year gone by. By Balaji Rao

The year 2020 is forgettable but the lessons should not be forgotten. The crisis and uncertainty did bring introspection among many who neither had proper back-up nor were prepared to face the financial challenges. One of the many challenges most individuals faced was drop in income or even worse, losing jobs; those depending on business income too had to face uncertainties with shop closures.

The fundamental mantra of being “cash-wise” is to build a fence of financial security around us. The following points would be handy to face tough situations that may come unannounced yet again in the future.

LOAN TO EARNING QUOTIENT

Loans basically are taken to fulfil dreams and aspirations and home loans remain the largest in quantum and longest with the tenure of repayment. Most of one’s income gets gobbled up for home loan EMIs and one should be prudent enough to plan the repayment capacities and to commit only such amounts that are affordable.

Ideally, the income should be split into three parts of 1/3rd each: towards mandatory household expenses; all types of EMIs; and investing for the future life goals. In simple terms, if one is earning ₹60,000 per month, ₹20,000 should be allocated for each of these three important aspects.

HOME LOAN INSURANCE

At the time of taking a home loan, the entire loan amount should be insured; during the course of the long repayment tenure if the borrower dies the insurance company would settle the loan dues with the lender and the house will be free of any mortgages in favour of the surviving family members. In fact, the one-time premium too can be clubbed with the home loan that gets merged with the overall EMI. So, there should be no reason why one should not insure the loan.

CONTINGENCY FUNDS

The pandemic has taught the best lesson of being financially prudent; one should keep aside either in a liquid fund (a low risk debt mutual fund) or in a bank fixed deposit six months’ worth of mandatory financial commitments including household expenses, all types of EMIs, rent (if any) and such other unavoidable commitments. For example, if the household monthly expenses is ₹15,000, EMIs ₹20,000 and monthly rent is ₹10,000, then ₹45,000 x 6 = ₹2.70 lakh should be invested separately to meet any contingencies that may occur unannounced.

FIXED OR FLOATING RATE

While the banks and lending institutions are quick to increase the rate of interest when the interest rates rise, they may not show the same enthusiasm during drop in rates (based on the monetary policy announcements done by RBI regularly). Yet, it would be a good decision to choose floating rate loan option than a fixed rate option.

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