According to Reserve Bank of India (RBI) guidelines, lenders can finance up to 75-90 percent of property cost as home loan. Therefore, homebuyers are required to contribute the remaining 10-25 percent of the property’s acquisition/construction cost from their own sources, in the form of down payment or margin contribution.
For example, purchasing a property of Rs 1 crore through a home loan with a Loan-to-Value (LTV) ratio of 70 percent would require the borrower to contribute Rs 30 lakh as down payment.
The optimal way to accumulate such a large corpus is to start investing for it, years before making the home purchase.
Here I will share a few dos and don’ts while building a down payment corpus.
Start as soon as possible
The earlier you start investing, the more time your money gets to grow and benefit from the power of compounding. Due to the compounding effect, even the returns earned from your investments would start generating returns, which eventually helps in building a bigger corpus over the long term.
The first step towards building your home loan down payment corpus is to find a ballpark figure for it after factoring in the average value of your target properties, inflationary trends in the housing sector and LTV ratio required for financing the acquisition through home loan.
Once you have estimated the target size of your down payment corpus, you should use online systematic investment plan (SIP) calculators to find out the monthly contribution to building your down payment corpus.
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Invest in equities for the long term
Borrowers, having an investment horizon of more than five years for building their home loan down payment corpus, should invest in equity mutual funds (MFs) through SIPs.
Equities, as an asset class, usually beat fixed deposits or other fixed income instruments by a wide margin for an investment horizon of five years and above.
Longer investment horizons also offer equities enough time to recover losses from short-term volatility associated with equities. Investing in equity MFs through SIPs would also allow rupee-cost averaging during market downturns while ensuring financial discipline through regular investments.
Prospective home loan borrowers should invest in FDs or other fixed income instruments, like short-term debt funds, only if they want to create their down payment corpus within five years.
As equities can be very volatile in the short term, investing in FDs or other fixed- income instruments would ensure growth certainty and capital protection for the down payment corpus.
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Try to build a bigger down payment corpus
The RBI has capped the LTV ratio for lenders at 90 percent for home loans up to Rs 30 lakh, at 80 percent for home loans above Rs 30 lakh and up to Rs 75 lakh, and at 75 percent for home loans above Rs 75 lakh.
The LTV ratio of home loan is the proportion of the property's cost financed through the loan. The final LTV ratio for the home loan would depend on the lenders’ credit risk assessment of applicants. Thus, home loan applicants should first try to accumulate at least 10-25 percent of their property’s value, depending on the loan amount, to ensure their financial preparedness for availing home loans.
Prospective home loan borrowers should always strive to create a larger corpus for down payment. Doing so might increase their chances of loan approval as making higher down payments reduces the credit risk for home loan lenders. Some lenders also offer lower interest rates to borrowers opting for lower LTV ratios.
Don’t sacrifice your other goals
In the pursuit of creating a bigger home loan down payment corpus, prospective homebuyers may end up ignoring the monthly contributions to the financial corpus set aside for other financial goals like child's higher education corpus, post-retirement corpus, etc.
However, doing so might force them to make much higher contributions towards the end of their financial goals, and, thereby, compromise on other financial goals or the overall standard of life during that period.
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Review your down payment portfolio
Mutual funds with outstanding past performance may not deliver the same performance in the future. Changes in their style of fund management or other market-related factors can lead past outperformers to remain laggards for a long period. Thus, consumers investing in mutual funds to create their home loan down payment corpus should review the performance of those funds at periodic intervals.
They should compare the returns generated by those MFs with their peer funds and benchmark indices, at least once in a financial quarter, and redeem the ones that consistently underperform their benchmark indices and peer funds.