Personal Finance

Financial Planning – Inculcating a good savings habit

Sridevi Ganesh | Updated on April 15, 2020 Published on April 15, 2020

Keeping track of expenses can help avoid unnecessary costs and improve savings

Harish, aged 37, met us for financial planning last month. He was contemplating buying a house in Chennai.

We advised him to look at the whole picture before taking a decision on a large purchase like that of a house. His financial plan was drafted after analysing his cash flow, his savings and other assets.

Annual Cash flow (₹)

Income

Salary income

16,80,000

Annual bonus

90,000

Total Income

17,70,000

Expenses

Rent

2,76,000

Living expenses

6,00,000

Car loan EMI

1,26,000

Child related expenses

2,50,000

Parental support

1,80,000

Total Income

14,32,000

Surplus

3,38,000

Net Worth (₹)

Assets

Fixed deposits

2,50,000

Loan to friend

5,00,000

Mutual funds

20,00,000

Provident fund

9,50,000

Gold jewellery

6,40,000

Car

7,00,000

Total

50,40,000

Liability

Car Loan

5,00,000

Net Worth

45,40,000

Harish wanted to buy a house at an estimated cost of ₹60 lakh. He wanted basic interior work to be done, which increased the overall cost by ₹7.5 lakh. We advised Harish to stick to this budget.

His wife, Prema, was not an earning member. They have a daughter, Arthi, aged 6. After a discussion on their lifestyle and savings habits, we understood that Harish and his family enjoyed spending and partying. They travel every year within India. They wanted to reduce their travel and other expenses but did not know how to do it. Hence, they decided to buy a house and commit to an equated monthly instalment (EMI) payment.

Such general piece of advice is quite common, and someone seems to have seeded this thought in Harish’s mind too. He was told that in any case, they were paying a rent of ₹23,000 per month; this could be saved once they move to their own home. The family received mutual funds worth ₹20 lakh as part of inheritance from his paternal uncle. Harish’s salary got revised recently from ₹1,25,000 per month to ₹1,40,000.

Observations

Harish

didn’t have a regular savings habit. His spending is high compared with his income. There are lifestyle-related spends such as buying a car and regular vacations. Harish has not committed to any savings so far except his provident fund (PF) statutory deduction.

Given this context, getting into a large liability commitment when he was the sole earning member was a bit risky.

Review & Recommendations

Harish could buy a house at a cost of ₹67.5 lakh, as budgeted. His regular EMI would work out to about ₹38,000 if he opted for a housing loan of ₹42.5 lakh at an interest cost of 9 per cent per annum with a tenure of 20 years. Banks would be inclined to lend up to 70 per cent of the cost of the apartment as housing loan, based on his employment with a well-known company.

The housing loan EMI would be 25 per cent of Harish’s take-home salary. He would be funding more than 30 per cent of the purchase cost through his financial assets. His credit score was well above the threshold required, and his track record of servicing a car loan added more credibility. With this kind of background, lenders would prefer a customer such as Harish in the current environment.

What was intriguing to us was not his financial ability to service a loan but the lack of savings habit and an inclination to spend without set limits.

We advised Harish to get back the ₹5 lakh that he had lent to his friend. These kinds of transactions are best avoided, and if at all, they should have a clear time frame. Harish estimated the family’s expenses to be ₹50,000 per month, a relatively high sum, as he was not able to save much, other than servicing his car loan EMI.

We advised him to track his expenses for the next three months and find ways of saving on them. Since Harish had no prior experience of investing in mutual funds and the associated volatility, we advised him to redeem his MF and move the money to fixed deposits / liquid funds as his aim was to protect the fund received as inheritance, and use it for the home loan down-payment.

Harish’s wife was inclined to take up a job, as she eventually wanted to start something on her own. She plans to join a nearby school soon and would be earning ₹20,000 per month. This additional income would provide the family a cash flow cushion.

We advised Harish to build an emergency fund of ₹6 lakh as the first step. We also told him to buy term insurance life cover for a sum insured of ₹1.5 cover and a health cover (family floater) of ₹5 lakh.

Then, he could opt for the house purchase that would entail an EMI of about ₹38,000. We explained to him that he would be paying about ₹49.3 lakh as interest cost if he paid EMI for 20 years. We advised him to pay ₹1 lakh every year from the second year of the housing loan. This would help him reduce his total interest cost by ₹18 lakh over the years and he would be able to close his housing loan in 13-14 years.

Harish was advised to keep an eye on the interest rate, because if the interest rate went up, his EMI could also go up. Banks generally adjust the tenure to retain the EMI amount, but then the total interest will be higher in the long run. Rather, Harish was mentally prepared to pay a higher EMI if rates went up. We also advised him to save 10 per cent of his income towards his retirement and his daughter’s college education. He was also advised not to change his car for the next five years.

(The writer is a SEBI-registered investment advisor at Chamomile Investment Consultants)

Cost cutting

Regularly prepaying a portion of the home loan and paying the same EMI will reduce the total interest cost in the long run.

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Published on April 15, 2020
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