The ongoing Covid-19 crisis is forcing people to make some tough economic choices. In a series of three articles, we’ll look at three such choices you may have to make. So here’s the first: if you have to choose between continuing your SIP or paying your loan EMIs during the ongoing moratorium, what should you choose?
The answer, in this case, is straightforward.
If your income is strained to a level where you have to pick between paying your EMIs and continuing your SIPs, pay your EMIs.
Even though you have the option of delaying your EMIs with the RBI-mandated moratorium of six months, you should prioritize paying your EMI dues.
INVESTING IS OPTIONAL BUT EMI IS AN OBLIGATION
Investments, while critical to your long-term wealth-creation eﬀorts, often tend to be optional. They can be paused or cancelled. On the other hand, repaying your loan is an obligation that must be mandatorily met.
ONE MISSED EMI MEANS PAYING SEVERAL MORE EMIS
You should avoid using the moratorium while you have the income to pay your EMIs. This is because even one missed EMIs could potentially lead to several more EMIs during the tenure of your loan. For example, if you deferred the ﬁrst ﬁve EMIs of a 20-year home loan, you’ll end up paying 30 more EMIs. Hence, using the moratorium while you can pay your EMIs, is a costly option.
YOU CAN PAUSE SIPS IN ORDER TO PAY YOUR LOAN EMI
Remember that you only need to pause your SIPs which does not require you to liquidate your mutual fund units. Once you have income stability, resume investing again. Hence this is straight forward, if your income is strained to a level where you have to pick between your paying your EMIs even during moratorium or continuing your SIPs, pay your EMIs.
SHOULD YOU LIQUIDATE SAVINGS TO PAY EMIs, EVEN DURING MORATORIUM?
This is a tough choice and the answer might be yes. Consider that the lowest risk instrument for a retail customer is a bank ﬁxed deposit or high-yield savings accounts, followed by a liquid mutual fund. The category returns for one-year (forward-looking) ﬁxed deposits today are 4-6% depending on which large bank you choose, and the one-year (backward-looking) liquid mutual funds returns are also 5-6%. Hence, your post-tax returns on low-risk instruments are 4.20% on the ﬁxed deposit and 5.64% on the liquid mutual fund in the example in Table 2. However, your interest rate on your home loan is closer to 8% per annum and your personal loan is 10%+ and credit card debt is 30%+.
Now consider the liquidation cost of breaking your investments and, as always, calculate this basis your speciﬁc circumstance. But for this example, let’s assume you are breaking a ﬁxed deposit and thereby paying a -1% penalty on the breakage which is an eﬀective loss of principle. Despite the liquidation cost, you may be better oﬀ liquidating that deposit earning 4.2% and additionally incurring -1% penalty, and paying oﬀ your home loan accumulating interest at 8%.
Therefore, it may be in your long-term interest to liquidate your savings to pay your EMIs, even during the moratorium.
BankBazaar.com is India’s leading online marketplace for loans, credit cards, and more.