The Hindu Business Line : Debt balancing an integral part of financial planning

Sathish, 33, works for an MNC. His wife, 29, has been working in a private bank. Sathish had gone to USA on a three-year onsite assignment and returned in 2007 with a saving of Rs 20 lakh. He has a three-year-old, school-going son. When Sathish moved to Chennai, he bought a flat worth Rs 45 lakh with a loan of Rs 25 lakh when the interest rate was 11 per cent. Subsequently, he took a top-up loan for Rs 5 lakh at 13 per cent interest.

Currently, the home loan interest is at 13 per cent and the top-up loan is at 16 per cent. He intends to start a business from the beginning of July 2009 as a design consultant, for which he will require Rs 10 lakh towards initial investments, rental deposits and working capital. From the first month he hopes to earn a business income that would match his present salary.

He plans to lease office space at Rs 20,000 a month, subject to inflation adjustment annually. He wishes to send his son to a top B-schools in 18 years after getting an engineering degree.

His remuneration and other benefits from his employer are as follows:

His current salary is Rs 60,000 and take home is Rs 46,000 (after deduction of car loan and taxes). His salary is likely to go up by 20 per cent in January 2009. Sathish and his employer both contribute 12 per cent of salary towards PF. He is also covered by group medical insurance. He is allowed leave encashment up to 180 days and fuel expenses are reimbursed.

The company pays Rs 10,000 per annum for child’s education. His company has a policy to reimburse up to 5 per cent per annum on home loan interest if it’s occupied by the employee.

His wife earns Rs 25,000 (net pay Rs 21,000). Apart from medical cover, his wife is eligible for a Rs 3-lakh loan at a nominal interest of 4 per cent from her organisation.

Sathish’s current assets and liabilities are as follows:

Assets : Residential house Rs 60 lakh, mutual fund units worth Rs 2 lakh, car worth Rs 4.5 lakh, jewellery worth Rs 20 lakh, insurance policy with a annual premium of Rs 50,000, term of 15 years and sum insured of Rs 12 lakh (cash value is Rs 7 lakh) with balance term of 7 years. He also holds NSC worth Rs 1.5 lakh. Current balance in PF account is Rs 2.5 lakh.

Liability : Home and top-up loan of Rs 30 lakh, car loan Rs 1,75,000 (interest-free loan from employer with an EMI of Rs 6,250. Twelve instalments already paid).

Goals : He plans to save for his child’s higher education (fee for business school at today’s cost is Rs 18 lakh). For the engineering course he requires Rs 6 lakh at today’s value. He wants to arrange capital in a year’s time for his business.

He pays EMI of Rs 28,415 for the Rs 25-lakh home loan for tenure of 15 years and Rs 11,377 for top-up loan of Rs 5 lakh. Since the top-up interest has gone up steeply, he wants to close the loan.

He wishes to save for his retirement assuming that his current monthly expense is Rs 20,000.

Solution

Child’s education: It would take another 156 months for your son to enter the engineering stream. Based on your current age you can opt for an asset allocation pattern of 70 per cent of the savings in equity and rest in debt.

The current value of Rs 6 lakh (engineering fee) inflated at 5 per cent will be about Rs 13 lakh. Based on the above asset allocation pattern and considering post tax earnings (especially on debt) you should try to earn 12 per cent per annum. To reach the target you should save Rs 3,458 a month for 156 months. The cost of post graduation after inflation works out to Rs 41 lakh. With a similar allocation ratio, you have to save a monthly sum of Rs 6,138 for next 204 months to reach the desired corpus.

Capital for business: Your financial assets such as provident fund, mutual fund, insurance and NSC appears insufficient; you may have to borrow to meet your capital requirement. However, this would be difficult unless you rejig your current liability. First, you can try to swap the top-up loan against your insurance policy. The current cost of borrowing against insurance policy works out to 9 per cent; this will straightaway save 7 per cent for you. If you opt for this swapping, your current monthly surplus will increase by Rs 6,000.

If you take a loan of Rs 6.3 lakh after closing the top-up loan, the balance along with PF, mutual fund and loan from your wife’s bank would help you to cover a substantial portion of the capital. It will take anywhere between 4-5 months to get your PF final settlement after your quit your job. So it is advisable to swap PF against the top-up loan but only issue is that you will be eligible for 90 per cent of your current balance.

For the shortfall you can raise loan against your national savings certificate after adjusting the leave encashment of 180 days for the balance car loan.

Retirement: Assuming current expenses of Rs 2.4 lakh per annum inflated at 5 for inflation along with two per cent for increase in standard of living, at the start of 2035, your annual requirement will be Rs 14.9 lakh.

To have this pension at the start of 60 you should have a corpus of Rs 2.96 crore and it should earn inflation adjusted return of 2 per cent to sustain till you attain age of 85. To have this money you should start saving Rs 12,150 a month for the next 324 months with a return of 12 per cent.

Your current income will not support this savings. Hence, once your business income improves you can step up the savings.

(Queries can be sent to financialplanning@the hindu.co.in

More Stories on : Investments | Financial Markets

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page