Should You Buy Home Loan Protection Plan

I was having a discussion about whether to buy a Home Loan Protection Plan (HLPP) when someone has taken a home loan. The idea of HLPP is very noble, since any person taking a home loan would like to ensure that in the unfortunate event of his/her death, the family can continue living in the house. The HLPP ensures that in case of death of the home loan borrower, the insurance company will pay back the remaining outstanding loan amount to the bank.

What is HLPP and why it is needed?

It is well known that buying a house is the most important financial decision taken during one’s life. I would rather defer the buying of a house to mid-40s but at any stage of your life if you decide to take the plunge of buying a house, typically by availing a home loan, you need to worry about HLPP.  If the house is bought through home-loan it increases the risk profile since the person owes money to the bank. In essence, a person creates a huge liability by taking home loan and in case of an unfortunate death of the borrower, if the survivors can not pay the EMIs, then the bank has the right to sell the house to recover the loan amount.

This is the reason most housing finance companies will try to sell a protection plan (HLPP) to the home loan borrower.

A home loan protection plan is one whereby in the event of your death or disability resulting in loss of income, a sum of money will be made available towards the repayment of your loan. This ensures that your family or dependants do not have to worry about the loan repayment and your home will not be taken away by the bank.

How does HLPP works?

Let us take an example of a person taking home loan of Rs 20 L for the tenure of 10 years at say 12% interest, then the EMI calculated would be Rs 22021 per month. Let us assume that the borrower is paying the EMI regularly for next 10 years and now the outstanding loan amount is Rs 15 L. If the borrower dies after 10 years, the HLPP insurance will pay back the outstanding loan amount (Rs 15 L) to the bank. This is exactly similar to a term insurance plan except that the life cover will be equivalent to the outstanding home loan amount as per home repayment schedule (shown below).

Is HLPP same as Home Owner Insurance/Home Content Insurance?

The HLPP is fundamentally different than a House Owner Insurance or a Home Content Insurance. A Home Owner Insurance is insurance for the house (building structure) you have purchased (under construction or built) and provides protection against the risks to property such as fire, riot, flood or any weather damage. There are three types of coverage included in such insurance

• Replacement cost coverage: Cost of replacement of property regardless of appreciation/depreciation
• Actual cash value coverage: Cost of replacement minus depreciation
• Extended replacement coverage: Cost of replacement including the increase in construction costs 

A Home Content Insurance is for the contents of your home. This coverage is for the loss or damage of the valuables inside the home like the electronic and electrical goods, furniture, clothing, jewellery and any other precious contents inside the home. The contents are covered on the market value of the items and in case of a loss the insurance claim is paid on the value of purchasing a similar new item exempting the depreciation value.

I will only talk about the HLPP in this post.

What are the cost of HLPP?

The HLPP costs are similar to the term insurance costs with various premium payment options. The various options as of now offered are:

1) Single premium payment: A single premium is paid while taking the insurance. Also most housing finance companies will try to club this single premium in the home loan amount itself.

2) Equated Monthly Instalments: This is similar to any other term insurance plan with premium payment frequency to be yearly, quarterly or monthly. In most cases this EMI is bundled with the home loan EMI. Some HFC have come up with reducing EMI plans since the sum assured also is reduced progressively.

3) Limited Pay Option: Some HFC provides the option of paying only till a limited duration within the loan tenure. For example, if loan tenure is 15 years, the option would be to pay EMI only till 10th year.

If you use the some home loan protection calculators, the premium amount for a home loan of Rs 20 L for 20 years tenure with age of borrower 30 years comes out to be

• 49160 Rs for Single premium
• 8870 Rs PA for Limited Pay Option [EMI till 13 years] : 115310 Rs Total
• 6946 Rs PA for EMI Option for full tenure : 138920 Rs Total

The cheapest Term Insurance plan for the same Rs 20 L for 20 years with borrower's age 30 years is Rs 3060 per annum and hence total outgo is Rs 61200. [I used this calculator.]

These are just rough figures based on the websites of various companies. But it is clear that the cost of HLPP compared to a pure term insurance is almost the same.

So why HLPP is not a good option?

When cost is not a key deciding factor for choosing an HLPP Vs. Term Insurance plan, then what are the other issues with HLPP? Here are some of the problems:

1) A pure Term insurance cover remains constant for the entire tenure, while after each EMI, the HLPP cover reduces. This is not very helpful since for almost similar cost it is preferable to receive a fixed monetary benefit rather than a reducing one. Isn’t it better, that in the unfortunate death after 10 years, your family should get Rs 20 L (as in Term Plan) instead of a Rs 15 Lakh (as in HLPP) based on reduced outstanding loan.

Some insurance companies claim that they offset this difference by reducing the premium amount over the tenure, but it is important to note that as a person ages, his risk profile goes up and so does the insurance premium. So any offset in premium reduction to take care of reducing sum assured is balanced by increasing premium because of increase in risk profile due to old age. This premium calculation should be clarified with the insurance company before signing for HLPP.

2) It is well known that Interest Rate fluctuation causes a change in the home-loan EMI amount or loan tenure. Typically, rise of just 0.5% of interest rate would increase the EMI term for additional year, however HLPP does not give you insurance cover for those additional year. I could not find it in any documents on the website and hence it is advisable to check this while availing such scheme. Also if the interest rate falls and the period of the loan gets reduced (& if at all the banks pass the benefit to the end customer), then the refund from the insurance premium is minuscule. This  also needs to be clarified before taking up the HLPP.

3) There could be a chance of a home loan foreclosure for some borrowers. If the home loan is taken for a tenure of 15-20 years and over the tenure if the borrower received some surplus money due to variety of reasons, he/she may choose to repay the home loan prior to the tenure. In such a case, the home loan insurance becomes void. But a term plan will continue and provide the additional security.

4) A HLPP may become also void if you try to switch from one Home Loan lender to another, whereas a borrower typically does to get a better deal on home loan interest. If you switch the loan, then you need to buy another HLPP insurance from the other lender.  This should also be clarified before taking up the HLPP plan. A term plan will remain with you and protect you despite any number of switches of loan companies.

Here is the summary of all the points:

It is important to also look at the various charges as well as exclusions and compare with Term plans before going ahead with HLPP. Also it is not mandatory to buy an HLPP while taking a home loan (sometimes mentioned by person you are dealing with). So I would recommend a Term Plan since the benefits far outweigh that of HLPP.

Health Insurance Portability

IRDA in its recent circular approved the portability of health insurance, allowing the customers to carry forward all the benefits of health insurance of previous policy to the new policy with different insurer.  This is really a good news for all of us, since choosing any particular health insurance is anyway an onerous task.

What exactly is portability?

To understand the benefits of portability, it is important to understand “what are the benefits health insurers provide for renewing the policy with same insurer”?

1. Waiting period of pre-existing illness: Most health insurers in India have a waiting period of 2-4 years for inclusion of pre-existing illness. So if you take a policy today, expenses related to any pre-existing illness will not be covered till you continuously renew the policy for next 2-4 years.
2. No claim bonus: Most health insurers offer a no claim bonus of 5-10% (discount) on the premium if you continue with the same insurer and have not made any claim for any medical expenses. Some insurers have introduced this discount on premiums irrespective of claim status.
3. Initial waiting period after policy starts: Most insurers have a waiting period of 1-3 months when the policy comes into force, during which time only the accidental expenses will be covered but no other medical expenses can be covered. This waiting period does not exist if you re-new the policy with the same insurer.
4. Waiting period of coverage of certain exclusions: Some insurers have a waiting period of 2-4 years for specific illness or for senior citizens. As an example, stone in kidney or cataract are excluded for 2-4 years if a senior citizen starts a new health insurance policy.

In essence, these are the benefits of remaining loyal to the same insurance company. In the current scenario, these benefits are lapsed if you try to switch to another insurance company, which is unfair as far as customers are concerned.

Why customers want to switch from one insurer to another?

There are several reasons why a person may want to switch to another insurer:

1. Poor Service Record: This is the most common reason for switching to another insurer.
2. Premium amount saving: Another insurance company may provide higher sum assured at lower premiums than the current insurance company.
3. Specific coverage: The other insurance company may be providing coverage of any specific illness which the current insurance company is not providing. As an example, most personal health insurance policies does not provide cover for maternity expenses but Max Bupa policy provide that cover after a waiting period of 24 months.

So, IRDA plans to ensure that if a customer is not happy with his current insurance provider and wants to switch to another insurance provider, all the benefits accrued for continuing with the current insurance provider will remain intact and can be carry forward to new insurance policy. For example, if your current insurance policy has a waiting period of one year for pre-existing illness and if you switch to a new insurance company with new policy that has a waiting period of two years for pre-existing illness then with portability in place, you only have to waiting period of one year in the new policy for the pre-existing illness coverage. 

Issues with portability

The portability concept is definitely good for disgruntled customers but I think that it does come with some issues:

1. The credit for the waiting period is limited to the sum assured under the previous policy. So for example your existing policy has sum assured at 2 lakhs and if you want to take up new policy of sum assured at 5 Lakhs with a different insurance company, the credit will only be applicable for the 2 Lakhs basis. This calculation can be very confusing for end customers.
2. It will be a huge task for the end customer to find another policy that has all the benefits of his existing policy and some more at the same premium rate to motivate for a switch. For example, if a person wants to switch to insurance company B from insurance company A, say due to lot of paperwork and poor service related to claim settlement, he needs to ensure that insurance company B not only provides good service but also has similar benefits (similar coverage etc) of the policy as provided by company A. If that is not true, there is no point for making the switch.
3. I believe that most insurance companies will close older policies and bring new policies to ensure that they do not loose due to the new portability rules from IRDA. This is because the entire concept of waiting period  came from the fact that companies wanted to retain their existing policy holders. This waiting period is typically useful in cases where the company increases the premium rates but the end customer has no choice to move to another insurance company since otherwise he would loose all the benefits. But with portability, most insurance companies loose this advantage. Hence, I think the policies will be changed. 
4. There would definitely be cases where the current insurance companies will be reluctant to let the customer make a switch and may cause operational delays or may cause policies to expire due to variety of reasons. This may result in increase of complaints. [Similar thing has been observed in mobile number portability]
5. Some insurance companies may try to ask customers to use credit cards to renew their policies. The trick is that in the “Terms and Conditions” section (one of the rarely read part) it could easily add a clause to give the right to the company to renew the policy (say one month before expiry) by charging the credit card automatically. This is typically done by web-hosting companies. This ensures that onus of cancelling the renewal payment lies with the customer who in majority of cases will forget the policy expiry dates.

I do think that portability game will bring some standard into the health policies and it will be easier to compare them but it will also bring some of its own issues.

Succession Certificate–what and how?

I got a nice comment on my earlier post on nominations which mentioned a slight correction in the post about the PPF withdrawal limit of 1 Lakh. The comment mentioned that if the person has a succession certificate then the entire amount will be given to the legal heirs. Let us talk more about this “succession certificate”.

A succession certificate is a document obtained for a deceased person who did not have a will. It contains the list of deceased person’s debts and securities. The problem is that most people think that if the succession certificate is obtained then the person is the rightful owner of the deceased person’s properties, which is not the truth.

A succession certificate allows the person to act exactly similar to how a nominee would act. It gives the authority to the holder for distributing the deceased person’s assets. So how would the person decide to distribute the assets? He has to look at the succession law and based on that he decided to distribute the assets.

The way to obtain the Succession Certificate is to

1. Make an application to the district judge (where the deceased person is residing).
2. The application should contain details about the time of death of the deceased person, the place of his/her residence, details of all the legal heirs, the debt and securities in respect of which the certificate is applied for etc
3. If the district judge is satisfied with the application and accepts the legal ground for entertaining the application, he may assign a hearing date.
4. The court will issue notices to all the concerned parties (typically all legal heirs).
5. A newspaper notice has to be issued apart from the mandatory notice to the respondents. A typical wait period for this notice is 1.5 months from the date of publication.
6. After the hearing, if the district judge decides that the right of Succession Certificate belongs to the applicant, the judge will pass the order to grant the certificate.
7. Once the order is passed, the applicant has to submit judicial stamp papers and court fees as per the court rules.
8. It is important to note that the court fee is a percentage of the value of the asset with a maximum limit. So if the asset value is very high, the court fees could actually be very handsome. (Say for flat of Rs 40 Lakh, the fees could be Rs 75000)
9. It typically takes 3-4 months for the entire procedure to be completed and getting the certificate.
10. Once you have the certificate, you are authenticated to distribute the assets to the legal heirs as per the succession laws.

The succession laws in India are very complicated and are very different based on a person’s religion (for e.g. Hindu Succession Act & Christian Law of Succession).

Disclaimer: Please note that I am not an expert in legal laws and it is advisable to visit a qualified lawyer for any truthful information on such laws before making any legal moves.I do not take any responsibility, if you read this post and act based on it.

Beware of Equity SIPs

SIP or Systematic Investment Plan is very well known for mutual fund investment. The advantages of investing through SIP mode that typically proclaimed are :

• Rupee cost averaging
• Disciplined mode of investment
• SIP methods works irrespective of the current market level

These are great advantages, especially for retail investors. So some brokerage companies have started providing facility to invest in the SIP route for individual stocks. This is “Equity SIP” which is the new buzzword. There are two types of SIP investment allowed:

• Amount based: Fix the amount to be invested at regular intervals
• Quantity based: Fix the quantity of shares to be invested at regular intervals.

This sounds like a great way of investment on the face of it, but is it really that good? Let us try to analyse whether a retail investor will get the same benefit of SIP investment as mutual funds:

1. Rupee cost averaging: The key advantage that is mentioned for SIP investment is that even in volatile markets this is a great tool due to rupee cost averaging. The key to cost averaging is that if market is down, you will get more units and if the market is up, you get a higher portfolio value. This sounds great and it definitely seem to work for individual stocks as well, but the rupee cost averaging can only average out a less volatile stock (which is mostly true for mutual fund due to inherent diversification). If a stock (& for that matter mutual fund) is extremely volatile, then this method may not be able to average out your losses. In essence you need to find a good stock with high growth potential and less volatility to use rupee cost averaging.
2. Disciplined mode of investment: Yes, this method definitely forces investors to shell out money at regular intervals, but it is useful only if over a long period you are increasing your wealth. If you invest regularly in a stock which is sliding down over a long period then definitely it is not a great investment even if you are putting money at regular intervals. In essence you need to find a good stock with high growth potential and less volatility to make disciplined mode of investment.
3. SIP works irrespective of market level: This is true because at lower levels you will get more units and the rupee cost averaging kicks in for mutual funds. This does not apply for individual shares though. Will it really makes sense to invest when you know that the particular share has just tanked to the bottom. Some of the stocks never recover and so will your SIP investments.

If I look carefully, Equity SIPs does not sound as attractive as it is made out to be by the brokerage houses. The brokerage charges for Equity SIPs are same as those for investing directly into shares and hence it does not offer any advantages. So does it mean that retail investor should never look at Equity SIPs? Well not actually, since I feel these are great tool of investment if :

• You invest in exchange traded funds (ETFs) which are passively managed and hence less volatile
• You invest in quality stocks which are strong in fundamentals and currently undervalued
• Brokerage houses start giving additional benefits like lower charges for this disciplined investing

I am using Equity SIPs for Gold ETFs as a long term investment.

How to choose Health Insurance?

When I wanted to buy a health insurance, I was completely baffled by the plethora of choices in the market offering different types of plans. It is an extremely difficult task to really select the medical insurance plan which will satisfy your needs.

There are two kinds of health insurance plans, the one is the traditional mediclaim policies (similar to the policies taken by companies for their employees) which does a reimbursement of any medical expenses incurred, the other way is the critical illness policies offered by life insurance companies which provide a lump sum for any critical illness. I will talk about how to choose the first kind of policy.

Some of the key questions to ask while selecting health insurance:

1) The Annual Limit: What is the annual limit of reimbursement per year. It is a good idea to choose around 3-5 lakhs since the medical costs are going up day by day.

2) Sub-limits : What are the various sub-limits in the policy? The most typically caps are on room-rent, ambulance services, doctor’s fees or diagnostics.

3) Co-payment Clause: Is there any clause of co-payment for certain cases? Some policies have co-payment clause either after certain age limit, some may have the clause of co-payment for kids, some may have this clause for specific treatments.

4) Pre-existing coverage: Does the policy cover the pre-existing illness? Some policies cover it from day one, some cover only after a specific time period (say 2 years).

5) Exclusions: Most policies will have some or the other exclusions. The exclusions come under permanent exclusions or time-period based exclusions. So for example, suicide related expenses are excluded permanently in every medical insurance. But for maternity benefits a policy may have a exclusion only for first 4 years.

It is very difficult to find a single policy which will have all the features and hence it might be a good idea to purchase 2-3 policies with different features to cover all medical possibilities.

Tax Saving Tips

Nothing is certain but death and taxes. The time of the year has come to think about your taxes for the last financial year. If you are a first timer in paying income tax, this guide might be helpful (may be out-dated a bit).

But do you really give a thought while investing for the purpose of tax-saving? The Income Tax law is complicated due to the variety of cases it needs to cover, but even for seasoned professionals certain aspects of Income tax laws are confusing or not knowledgeable. Here are some tips which might be helpful for some extra saving of tax:

1) Get insured but with a caveat: With the new DTC proposal, all life insurance policies whose sum assured is greater than 20 times the annual premium, the maturity proceeds are taxable as normal income. So if you are trying to buy any life insurance policies just to save tax, be aware to have annual premium less than 5% of sum assured. This does not apply to term insurance though, since there is no maturity proceeds.

2) Use losses in stocks to save tax: Short-term capital losses can be set off against both short-term as well as long-term capital gains. This is something most people often miss, especially for salaried employees who do not seem to account the stock losses in the IT-declaration proof submission to the employer.

3) Pay rent to your parents if you stay with them: If you stay in a house owned by your parents (or even spouse) and if their income is not significant (especially true to senior citizen parents), then you can pay them rent which can be used to save against HRA. The person receiving the rent has to pay taxes though if the income exceeds the stipulated amount.

4) Use alternate LTA claims: Typically LTA claims can be taken only once in two years. So if you & your spouse both are working, you can decide to alternately claim the LTA benefit with your respective employers.

5) Give loans to your children: If you give a lump-sum amount to your major children as loan (interest-free), you can avail of the tax-benefit since no income or gift tax is applicable on such a loan. This is similar as giving them a gift, the difference would be that when you gift the ownership of the money gets transferred to your children.

Inflation Index Funds

Inflation is definitely a cause of worry for every individual. If the purchasing power of money keeps getting reduced, then a person will not be able to sustain present living standard, unless his income is increasing proportionately.

Inflation is such a beast that it not only makes your present life difficult, but can ruin your savings/investments for the future. It is to be noted that before May 2005, SEBI prohibited any capital-protected products. But now SEBI, relaxed these rules, allowing issuers to offer funds that provide capital guarantee. Currently there are numerous fund houses marketing such capital guarantee funds, but inflation turns out to be a real beast.

It is no wonder that the “mehangai dayan” song is such a hit.

I am just waiting, when the government or financial institutions will start launching a inflation protection funds. Such inflation-indexed funds are not a novel idea and they definitely exists in other parts of the world. For e.g. Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation.

Reserve Bank of India published a paper on inflation-index funds [PDF] in December, indicating that these might become reality soon in India.

It is proposed that we may issue  IIBs wherein the principal is indexed and the coupon is calculated on the indexed principal, as set out in the discussion paper on Capital Indexed Bond issued by the Bank in 2005. 

In simple terms, here is how it works :

Assume the IIB are released with a 10-year bond with 2% interest to be paid semi-annually. It means every six months, interest at 2% will be calculated and paid to the investor. Assume you invested Rs 100 in January. So after six months, the interest needs to be paid. But before the interest is calculated, the principal is adjust to current inflation rate. In this case the principal (Rs 100) is first adjusted for inflation (assume 8%). So the inflation adjusted inflation will be Rs 108. The 2% interest will be calculated on this inflation adjusted  principal thus giving higher returns.

The key benefits of such a investment avenue is that it is risk-free way to beat inflation although the real returns are not very spectacular. It will be a great tool as a portfolio diversification method and specially useful for conservative investors or senior citizens.

EMI Calculation– An Example

I wrote about how EMI is calculated and how to calculate EMI using MS Excel. It is not a big surprise to me that these are often the most viewed posts on my blog. Some of the readers commented on giving an example along with the posts, so here is the post explaining EMI with an example:

Example 1:  Assume that you take a loan of Rs 100,000 at 8.75% per annum rate for a tenure of 10 years. How to calculate the EMI?

  Open the excel sheet and click on fx.

Choose the Financial category and select the PMT function.

In the function arguments, enter the values. In our example, our interest rate is 8.75%, so enter “8.75%/12” The Nper is the tenure in terms of months, in our example it will be 120 months, the Pv is the Loan amount and keep Fv & Type to 0. Press OK.

When you press OK, you will see the result in the selected cell as shown. The EMI is Rs 1253.27 for our example.

What is the interest component of say 10th EMI?

Proceed as in above, but choose the IPMT function rather than the PMT function. The following inputs are required:

The only new input is the Per, which is the EMI for which you want to know interest component. In our example, we want to know the interest component for the 10th EMI, so input as 10. The result is Rs 693.75.

So, when you will pay the 10th EMI of Rs 1253.27, you are paying Rs 693.75 as interest component and remaining for reducing the principal.

What is the principal component of 10th EMI?

It works same as above except that you need to choose the PPMT function rather than PMT function.

If you want to know the principal and interest amount for each of your EMIs, then there are many calculators (excel sheets) available on internet. I like this advanced excel calculator since it takes into account any additional payment made.

Digital Data - an Asset

Our lives are definitely becoming more virtual and hence it is no surprise that when you think of making a will, you also need to consider your digital data as an asset. In simple terms, your will should answer the questions like “Who gets your email id after your death?”

With most of our lives going online, it is important to consider the data accumulated over our life-time as a data which should be either passed on to your legal heirs or totally destroyed. Digital data includes email accounts, social networking accounts, internet banking accounts, online photo albums, blogs and any data residing on your computer.

Why the heck would anyone want any access to your digital data? Why you should care? The reason is exactly the same with respect to your off-line assets like a house. You create a will since you do not want your legal heirs to fight over your assets and there is a good chance that they will fight over your digital data as well. I can easily think of legal fights over getting a dead writer’s un-published work or a ace photographer’s digital album or access to a extremely popular blog (which can be a revenue stream) in the event of a death.

The on-line assets are definitely more complex to come under a single umbrella of legal laws since each on-line website have different policies related to this issue. For example, gmail terms and conditions allows a legal heir to access the account if proof of death is furnished.

I reckon that in future digital data succession will become as crucial as any other offline asset succession and hence making a digital will become absolutely necessary.

When to make your Will?

This is a most difficult topic for most Indian households and oft ignored. I yesterday went to a friend’s place and he had called up a LIC agent to his home. I distinctly recollect that they talked in a very hush’ed tone, because he was discussing about how much money his family will get post his death. It was obvious that discussing death and money together is still taboo in Indian society and hence the same goes with making a will.

I think most people know what is will and it’s importance but still probably I reckon that 90% of Indian household never discuss this topic. I believe majority of Indians die without making any will, causing major dispute among legal heirs post any death.

It is so simple to make a will in India and so important especially with legal recourse taking many years that everyone should definitely have gone through this process. It is important to note that  assigning nominations alone does not help and a will is very important.

So when should a person make a will?

The question is never answered appropriately. As per the Indian Law, any person above 21 years of age can make a legally valid will. But the key point before deciding on making a will is to think about :

1. A sudden death is more probable in today’s fast paced life. So don’t think that you will not die till 80 years of age.
2. If you die intestate (without making will), your legal heirs are not only your spouse/children. Check out this Hindu Succession Act and you would know who all can be your legal heirs.
3. It is foolish to think that your legal heirs love each other and will never fight over your property. This has been found untrue in so many cases.
4. There is no threshold asset value, only above which legal heirs will consider it substantial for fighting.
5. The distribution of assets are done equally by the court of law without considering who is more needy amongst your legal heirs.

I would recommend that you should start thinking of making a will as soon as you get married. You can start with making a will on a simple white paper and asking your friends to act as witnesses. As you grow financially and acquire assets, you could add codicils to your will. If the number of codicils are more than five, then re-write a new will. You can think of registering your will once your assets have reached a substantial amount (you can decide what is substantial).  Where there is a WILL there is a way!!

 

AMFI plugs hole for Third Party scam

When investing in mutual fund schemes, it is very common to call up a broker and issue a cheque to him in the name of fund schemes. The cheque does not necessary be from you, so it could be from your spouse or your friend or as a matter of fact from anybody. The regulatory bodies wouldn’t have thought that this simple flexibility could actually lead to various scams.

Hence, to plug this seemingly innocuous hole in the mutual fund investment mode, AMFI has come up with guide lines to not allow any Third Party cheques[PDF] when investing in mutual fund schemes.

As per guidelines issued by the Association of Mutual Funds in India (AMFI), mutual funds are required to put in place strong processes by November 15, 2010 to ensure that Third-Party payment instruments are not used for mutual fund subscriptions.

So from 15th Nov, you will have to issue cheque from your account when investing in mutual fund in your name. The few exceptions are like parent investing on behalf of minor child or employer on behalf of employee.

But what is the Third Party Scam? It is simply a common case of trusting a middle-man and not doing due diligence. Here is how it works: You ask a broker to suggest a mutual fund scheme, and issues a cheque against that mutual fund scheme. He will fill a form and get your signature, but the problem is not in filling the form or not reading it properly, the actual problem is of trusting the broker. The broker can simply go home, shred the form you filled, then fill another form in his own name and submit the cheque along with the form issues by you. Since mutual fund accepts Third Party cheques, your money is being used by the broker to have scheme in his name. He simply needs to forge the receipt and give it back to you. The broker could simply redeem the money without you noticing anything.

The interesting aspect is that SEBI dis-allowed third party cheque in stock investment few years ago, but it is continued in mutual funds. I believe that AMFI has taken the right step in this direction, thus blocking these Third Party scams.

How to obtain your credit rating?

Every wondered why sometimes a bank refuses to provide you with that loan despite the fact that you satisfy all their criterion or why sometimes the credit card company refuses to increase your credit limit?

The answer typically lies in the fact that you may have a poor credit rating. CIBIL is India’s first credit information bureau. The CIBIL shareholding pattern is like this :

The CIBIL agency gets the information from its members about any individual person and creates a rating system. In simple words, whenever you go to any bank for taking a loan (car/house/personal), the respective bank contacts the CIBIL agency to verify your credit rating, which is based on your own history of borrowings and payments.

How does the credit report looks like?

The credit report typically looks like this [PDF]. It contains your personal details (like name, phone number, account number, address etc). It also contains the history of your accounts and your borrowing history and the way you have repaid your loans. It also contains the history of banks/institutions that requested for your credit report.

How can you obtain your credit report?

It is simple process.  You need following documents as mentioned on the website ;

It is important to note that there are no authorised agents for CIBIL who can get you the credit report. Check out the message indicated by CIBIL

Why it is necessary for you to get your credit report?

The reason you would want the report may simply be for informational purpose, but typically it will help you in understanding why a certain bank refused loan to you. Also there could be a possibility of your credit information being incorrectly stored in CIBIL data-base. In such case, you could actually contact the respective bank and ask them to make corrections and inform CIBIL of the correction as well.

Is there a security issue since all your information is with CIBIL?

Not really. The information is accessible only to you and the member banks (who already have your personal information). Also the RTI Act does not apply to CIBIL, since it is not a Public Authority.  Also the information is kept securely using state-of-the-art technology.

Check out the information about credit bureau in other countries.

0% EMI–An excellent mechanism and a good trap

There’s no such thing as free lunch. But marketers are promising exactly that with the 0% EMI schemes. You must have come across such deals especially while buying consumer electronics. The main claim of such schemes is to offer you an EMI scheme which will have

  no interest charges. This seems too good to be true, but in reality there are some really 0% Interest schemes. So what is the trap and how to know which schemes are really delivering a fully interest free EMI scheme.

Some few years back this was the most popular schemes for selling consumer electronics products especially with banks supporting and providing the finance. But RBI regulations advising banks to not indulge in such schemes have helped. The reason why the central bank decided to give a directive is because the scheme being promoted in a false manner. The problem with these schemes is mostly related to hidden charges. The way the charges are mentioned/categorised gives a false impression to the customer and making it difficult for the customer to have an informed choice.

Here are some hidden costs in the 0% EMI schemes:

1) Processing Fees: Such schemes typically asks for one-time processing fees for the loan. These are variable depending on the dealer/bank/purchase amount you are dealing with.

2) No Cash Discount: If you avail such scheme, any other discount provided by the dealer is not applicable. This is a real catch, since most of these 0% EMI schemes are promoted during festival period, when the dealers are willing to give lot of discounts to increase their sales.

3) Advance EMI/Down-Payment: These types of schemes typically asks for some part of the payment done in advance. In essence, you are not entitled for the entire amount of purchase to be converted into EMI.

4) Documentation Fees: Some offers ask your salary and if it does not meet a required parameter, they ask for certain documents. In such cases, an extra charge for document processing may be applied.

5) Availability on select models only: Sometimes the schemes are available only on select models/products. If this is the case, it surely indicates that the dealer wants to empty his inventory for these models which are probably old or not selling well.

6) Shipping charges/Installation charges: Sometimes dealers apply shipping/installation charges if you buy the product on 0% EMI scheme but no such fee if bought through cash.

7) Hidden conditions: Sometimes there are hidden conditions/restrictions while buying through 0% EMI scheme, which should be understood properly before signing the dotted line.

It is important to understand and calculate the real charges for such 0% EMI schemes before getting into one. As an example, if your purchase bill is Rs 36K, and availing 0% EMI scheme for eight months, with processing fees of Rs 1000 and forfeiting the cash discount of Rs 2000, the interest rate effectively turns out to be around 18.75%, definitely much higher than availing personal loans.

These schemes are not all that bad given the fact that the effective interest rate is still much less than using a credit card. Hence such schemes can be utilized by a consumer after carefully calculating the real rate of interest.

There are also some “real” 0% EMI schemes, where the manufacturer or the dealer absorbs the interest charges in favour of higher sales (may be for that specific period). So having an awareness is much better and wiser while availing such schemes.

Chasing the Sensex is useless

With BSE Sensex closing at spectacular high during the Diwali season, it made a big news all around. But chasing the Sensex has become an addiction to not only the media but the retail investors as well. The problem is that the euphoria corrupts the minds of retail investors and they start thinking of investing because Sensex is going up and not based on their understanding of the fundamentals of company. The question that came to my mind is that does it really matter to chase the index and to try to time the investment at lowest index to gain spectacular returns?

The answer comes out as a resounding “No”, and it is based on the historical data. I started digging at the BSE Sensex index history for the last decade starting from 2000 onwards. Let us assume that your investment exactly reflect the BSE Sensex performance. So let us compare the compounded gains when you invest at

1) Lowest Index each year

2) Highest Index each year

3) At a fixed date (say 1 Aug) each year

So if we look at the BSE Sensex for the past decade (2000 – 2010), it turns out that the index gave a CAGR return of 16.187% at lowest value investment, 13.125% return at highest value investment. The surprise is that when looking at historical data at a fixed date every year (1 Aug), the return is actually 15.501%, very close to investing at the lowest levels.

This is significant in the fact that instead of timing the market to find the lowest value, if a person invest every year at the fixed date in a steady manner, the returns are almost similar.

The key learning is to ignore the short-term sentiments of the market. If  you make steady and consistent investments, you would get decent returns without fretting over timing the markets.

Reverse Mortgage–It doesn’t work in India

Reverse Mortgage is not a very oft heard and used term in India, despite the fact that there are millions of old age people in the country. Just taking a peek at the Age Transition graph for India [Source PDF], it is clear that the population of old age group folks are going to increase many-fold from this year onwards. It is obvious that the entire old population is not going to be financially stable with the rising inflation & increasing health care costs and they would not have much means to earning in old age since the working age population will be growing as well.

The concept of Reverse Mortgage is very simple as shown below, where any senior citizen who owns a house can go to a bank. The person can avail the reverse mortgage loan from the bank by mortgaging the house to the bank. This loan ensures that the senior citizens can get a decent monthly income(based on the valuation of the house) till the senior citizen is alive and can stay in the house as well. It helps the “house-rich-but-cash-poor” people.

The whole idea is to ensure a financial monthly cash flow to allow senior citizens to live freely and independently. Upon the death of the person, the bank may return the house to legal heirs if the loan is paid back or else the house is sold and loan recovered, with the remaining amount paid back to legal heirs. An excellent post on what is reverse mortgage is here.

The concept is simple and on the paper it sounds to be a super-hit with the ever increasing population above 65 years in India, especially with the family support system breaking very fast. In my apartment complex itself, I have seen hundreds of old age people, who are staying alone with their kids settled out of country. But to the surprise of financial institutions, the scheme has seen a very damp response in India.

Let us ponder over why this superb scheme doesn’t seem to attract enough investors.

• The scheme targets the senior citizens, but who are currently the senior citizens? The folks who are above 60-65 years. These are the people who were born when India attained independence. These are the people who saw liberalization, when they were already past their youth. These are the people who had very less opportunities for earning money and with too many social taboos and rituals. These people never knew consumerism and did not know how to spend the money. They just know how to save money and make assets and that is why these people built houses sometimes more than one. The whole thinking of the current senior citizens is “What will I do with the extra monthly income, for which I need to sell my house?”, rather when I die, I will give these houses as assets to my children and my grandchildren.The scheme would make sense for people who are currently in their 40s-50s, and hence the banks should actually make these schemes available to people above 40s (definitely lot of varieties/conditions can be included for different age-brackets)
• The scheme is not marketed very well and very few people actually understands it. I feel that most financial institutions feel that dealing with senior citizen is very risky. The risk arises from multiple factors especially from the fact that they have not much alternate source of income (and exactly the reason they enter into reverse mortgage in the first place) and hence these people can not be pulled into other schemes of the bank. It is also important to note that the value of a house over a period of time will be sustainable when it is maintained properly, but with senior citizens having health issues and not much available cash, it would be difficult to do so. This may cause a deterioration of the house value over long periods of time. Also it is very difficult for marketing/sales people to deal with their idiosyncrasies and the paranoia. The fact that a banking institution while giving loan typically prefers a longer duration (in normal loans they have pre-payment penalty for early loan closure), but for senior citizen the risk of the scheme getting closed early is high and hence their is less chance to earn profits. Then their may be multiple issues of dealing with legal heirs in case of a death. So, all in all, senior citizens are not worth looking forward for in terms of making a customer base and hence banks have very little in marketing these products. In fact, I see very few schemes targeting the senior citizens and even if their are, they are not marketed enough.
• The legal framework is not very strong in India and which makes this scheme much more risky. There are moral issues related to these schemes, for example, if an old widowed lady is not able to maintain the house causing deterioration of the value of the house, would a bank take a legal recourse for ensuring say the roof be made leak-proof or to paint the entire house etc. It is very difficult to handle legal issues related to old people where the legal heirs are all settled outside the country especially when either the legal heirs are not interested or when the residual amount to be gained by them is miniscule. Also there may be issues of corruption when a broker/legal heir/bank employee may seek money outside the agreement (under-hand dealing) and sell the house at a very low-price, thus making a loss for the bank but a personal monetary gain. There could be issues where an elderly person discovers a major health hazard (not everything is covered by medical insurance) and which may require them to sell the house for treatment (or may be to move to a smaller house and use some money for treatment). In such a case, both the bank and the borrower may set to loose the benefit. Then their are multiple legal issues with priority of liens (
  It is a legal claim by one person on the property of another as security for payment of a debt.), in terms of taxes on the sale of the house and to prove the legal heir claims. The laws are not clear when a person or household declares bankruptcy, the issues of  senior citizens mortgaging the ‘other’ house and also putting it on rent (so essentially gaining money through rent as well as selling the part equity till they are alive).
• The upfront charges are typically high and these loans are rising debt loans. A typical loan, when repaid through EMI is a decreasing debt loans. So if you carefully understand how EMI is calculated, you would notice that some part of EMI goes towards lowering the principal as well, but with reverse-mortgage, the interest paid out get added to the principal and hence the debt keeps rising. The psychological barrier to this scheme is the loss of house equity as time progresses. Also since the ownership still remains with the borrower, the wealth tax, insurance, water charges etc have to be borne by the owner itself thus lowering the cash flow.

If I consider all the above scenarios, I would advice that this scheme is helpful only for those who do not have any legal heirs to pass-on the assets or to those who are desperate for some cash-flow (may be because their kids are no longer looking after them). This should not be considered as a means to fill the retirement goal corpus. Also it will take some time for the schemes to become more customer friendly.

Real Estate - Real Returns

                  Buy Land, They’re Not Making it Anymore – Mark Twain

Investing in real estate is crucial to Indians, especially owning the first house/apartment. In India, it is common to call it as investment but not to think of it as investment. Note this difference, since most people who “invests” in real-estate do not think about real return on investment (ROI) on real-estate investments.

I would be really wary of putting my hard-earned money in buying a house, unless I get a decent ROI especially when it needs so much efforts and also it may induce emotional trauma.

So what exactly is a ROI for a house and how to calculate it for real-estate investment?

If you are buying a house for purely emotional reason and if this will provide you satisfaction, then calculating ROI is useless. So if you are happy being a owner of a house, then you wouldn’t think of “returns” and ROI is immaterial. But, it is important to distinguish between owning a house for “satisfaction/being happy” Vs “showing-off/rat-race competition”.

But if you are the one who thinks buying a house will make you rich or it will make you financially stable, then you seriously need to calculate a real ROI on the investment.

Almost everyone must have heard about their lucky friends who bought an apartment for Rs 15 Lakhs almost a decade ago which is now quoting at Rs 50 Lakhs. This sounds like an amazing deal, isn’t it? Well not actually, since the CAGR return is just 12.79% which is not a great deal. So if the same 15 Lakhs would have been invested in BSE Sensex stocks, it would have ballooned to Rs 65 Lakhs, definitely better than real-estate.

Note that this is a simplistic view not considering multiple factors like efforts required for investment, overhead costs and risk factors. If these factors are taken into consideration real-estate investment will not sound attractive anymore. The graph below indicates that CAGR return of various asset class over past 10 year period. As indicated, stocks and gold out-perform the real-estate easily.

Some argue the virtue of real-estate investment by giving the leveraging logic. The idea is that if you buy a house, you would just give a 15-20% of cost as a down-payment (e.g. 2Lakh) and then see the real-estate price going up (say Rs 50 Lakh) and calculating the CAGR to be much higher (~45%). This is foolishness and simply twisting the truth to show-case an amazing returns. It is a fact that borrowing money is always costly (how would banks otherwise make money) and more risky. It is important to remember that the loan amount is owned by you, along with the interest to be paid to the bank. Also any decrease in the price of your house will in-fact be a huge loss rather than any gain at all. 

Let us compare some points while investing in Stocks Vs Real-Estate.

1) Performance: We already saw that the returns from stock are higher compared to Real-Estate investments.

2) Leverage Advantage: We discussed the leverage logic in real-estate. The same kind of leveraging can be done in Stocks as well.

3) Overhead Costs: The real-estate overhead cost is huge (10-15%) which consists of Stamp Duty, Brokerage Charges, Loan Processing Fees, Legal Fees, Utility Connection charges etc etc. The costs for buying stocks is much less.

4) Taxes: Stocks score over here since you just have the long-term gain (if held over more than a year) but in case of real-estate one has to pay property tax apart from long-term gain tax on selling the house.

5) Transparency: The biggest advantage while buying shares is that you can use the web to determine the fundamentals of stock easily. The same doesn’t apply to real-estate investment. It is so difficult to determine a handsome bargain with so many variables that investing is more dependent on luck than a logical analysis.

6) Efforts: The real-estate investments really gets killed in this parameter. There is not only enormous efforts to find a good house, but once you own it, a lot of effort is needed to keep it in good condition.

7) Diversification: If you invest in stocks, it is so easy to put your money spread across industries/companies/funds to give it protection. This can not be applied to real-estate investment at all.

I feel that the real-estate prices in India are not at all justified and the hype is driven by the artificial demand. Also most people can afford to get into this thanks to easy loans from banks. I hope the bubble does burst early enough to save lot of people who are not in the trap yet.

IPO Investment – Myth Busted By Statistics

IPO investments are definitely a hype. I don’t like IPOs as a investment due to the excessive marketing which makes it much tougher to find the fundamental value of the company and makes a retail investor more gullible.

IPOs just make gullible investors get excited by creating excessive hype, especially with the promise of making the investor super-rich in a shorted period of time. I have read The Intelligent Investor by Benjamin Graham and remember that  he also recommends that investors should stay clear of IPOs. The simple reason is that IPO is raised to get capital which results in a premium price and offers a very little choice to buy the stock at a discount.

So just to validate this I decided to look at all the IPOs from 1 Jan 2010 till now and to check out the issue price Vs current price of the stock and here is the table:

                     

If you look carefully, all the red-lines are the ones which are giving negative returns (essentially in loss), while all the orange-lines are the ones giving less than 10% returns. So this actually validates what Benjamin Graham has been preaching for so long:

1) Out of 57 IPOs only 21 IPOs are actually providing gains of more than 10%. So essentially only 36% of IPOs are giving decent returns

2) Out of 57 IPOs only 4 IPOs actually make returns more than double. So essentially 7% of IPOs are giving exceptional returns

3) Out of 30 IPOs in losses only 7 IPOs actually gives loss in single digits (i.e. < 10%). In essence, 77% of loss making IPOs are giving losses more than 10%

This definitely busts the myth that IPOs are a source of short term quick gains. Some of these IPOs can actually go above their issue price after certain years, but that again indicates that prices during IPOs are at higher premium.

The “get rich quick” hype generated during the IPOs are typically by the marketing companies and promoters of IPO companies to raise the premium price for mopping up more cash, but for the retail investor it is much better to wait for few days after listing, before investing in the IPOs and that too after the value study of the company.

The only people who possibly gain from IPOs are definitely other than retail investors.

Guarantor Liability

While learning about the nomination rules for various investment avenues, I got into thinking about the rules related to being a guarantor. The term is typically confused with a reference required sometimes. It is very common to see friends asking their office colleagues or family friends to become a loan guarantor.

I am sure that most people would be very willing to help the needy friend by readily becoming a guarantor without understanding the full implication. The most common mistake happens because a guarantor is thought of as a reference. The problem is that, in the ambit of law, a guarantor is much more than just a friendly reference.

The definition itself tells a lot

“A guarantor for bank loans means a person who promises to provide payment on the loan, or other liability in the event of default.”

It is pretty obvious why banking institutions asks for a guarantor, since lending money is always a risky business with lot of chances of default by the person taking loan. So guarantor is like another chance for the bank to recover the loan money. But with a huge liability, why would anyone want to be a guarantor? A father would readily be a guarantor for his son’s education loan due to emotional reason, but others are gullible enough to not understand the liability of a guarantor and the legal implications.

What happens on a loan default?

If you are guarantor to your friend’s loan and he defaults (essentially not paying the EMI), what do you think will happen? You would think that the bank will chase your friend for the payment. Also if he is unable to pay, bank may pursue a legal course against your friend for recovering the loan amount.

Well here is the shocker!! The bank can actually issue a legal notice to you as a loan guarantor along with chasing your friend for recovery. Supreme Court indicates:

"The legal position is clear that liability of the guarantor and principal debtor are co-extensive and not in alternative," said a Supreme Court Bench comprising Justices Dalveer Bhandari and H L Dattu bursting the myth that the principal debtor had the primary liability to pay up a defaulted loan.

In plain language, the bank (or who-ever lends the money) has full right to pursue both the primary debtor (who took the loan) as well as the guarantor at the same time.

            Liability of guarantor is exactly same as that of person taking the loan.

It is important to note that a guarantor involved in a defaulting case would have a negative impact on guarantor's credit history as well. Also once a default has happened, there is very little a guarantor can do except to talk to lender and borrower and try to make a settlement.

So be very careful when providing a guarantee, since being a guarantor is akin to taking the loan yourself without getting the money.

Nomination and weird rules

I am regular reader of JagoInvestor and recently came across this awesome post on nomination by Manish. I thought, I was well versed by the nomination rules and understood the concept about the difference between nominee and legal heirs. Well, to my surprise, I did find some shockers and it left me amazed by the absurdity of the old rules which probably needs some change.

I would suggest you go through the entire post, but here are the two shockers that hit me:

1) Nomination in Shares: In the basic sense, a nominee is just entitled to receive the money disbursed by the company and is responsible for distributing it to the legal heirs. But in case of shares, the nominee is the one who is the owner of the shares unless you have left a will. Here is what Manish writes

It means that if you have not written a will, anyone who has been nominated by you for your shares will be the ultimate owner of those stocks, The succession laws on inheritance will not be applicable but in case, you have made a will, that will be the source of truth.

2)  Nomination in PPF: I am just quoting Manish verbatim:

Let me give you some shock first. If you have Rs 10 lakh in your public provident fund (PPF) account and you have not nominated anyone for your PPF account, your legal heirs will get maximum of Rs1 lakh only! Yes, it’s so important to have a nominee, now you get it . You can nominate one or more persons as nominee in PPF. Form F can be used to change or cancel a nomination for PPF. Also note that you cannot nominate anyone if you open an account for a minor.

This is a real shocker, since in both cases, it becomes absolutely mandatory to have nominee assigned as well as a death-will clearly mentioning whom you want the money to go after your death. The conclusion is that you have be absolutely careful while filling nomination forms and you should plan for leaving a will. Thank you Manish for the wonderful post.

UPDATE: One of the interesting aspect about, not having a nomination for the saving account and when you try to claim that money as a legal heir, is that the banks fix a threshold limit of the money lying in the saving account, within which bank only expect a letter of indemnity for any claim. But if the money lying in the saving account is more than the threshold limit, then banks needs multiple documents (Letter of Indemnity from all claimants, Claim Form signed by all claimants etc), and it will try to make enquiries that there are no other claimants to the money lying in the saving account. Another thing which banks needs in this case is “Surety”. A surety is a guarantee to assume responsibility arising out of any future claimant for the money in the saving account.

The threshold limit can vary from bank to bank (for e.g. State Bank of Mysore has a threshold limit of Rs 50K[PDF]). So say if you want access to the money in saving account of your deceased parents in State Bank of Mysore, if the balance is < Rs 50K  you just need to furnish letter of indemnity, but if the balance is more than that (say 2 Lakh), apart from multiple documents that you need to submit, you may have to submit a surety of amount much larger than the balance (may be  say Rs 5Lakh) depending on the bank.

Future of Credit Cards

Remember Aamir Khan in Ghajini giving credit card to the chaat-wala? Well, the credit cards have almost become ubiquitous at-least in the urban India and I think it wont be long before it would engulf the far-reaching rural areas including the chaat-walas. Although I do hate credit card, but there is no doubt that this is going to be the default mode of payment in future.

The credit card companies make a load-full of money sometimes not by ethical means but they are also spending a lot of money in the future technology of credit card which may be more secure and more useful for the end consumer. So what’s the future of credit card? Here are some glimpses:

1) Multi Account Credit Card

The Multi Account Credit Card has two buttons on its face each with an indicator light. So you can essentially have two accounts in the same card. You can also have a credit and a debit card rolled into one. The card contains a lithium-polymer battery inside can last four years under high usage. They're also fully waterproof,

 

2) The Hidden Credit Card

This card does not display all the digits of your account number and some digits are hidden. This credit card has a keypad and black-and-white display for six of the digits in the card's unique number. Once the correct PIN is entered on the card's four buttons, the missing digits are filled in and the card's magnetic strip is populated with data. Both the digits and the strip become blank again after a short time. If the card is lost, no-one can use it.

3) Contact Less Credit Card

These are essentially chip-cards that works on the RFID mechanism. The idea is that you do not need to swipe and you can just wave the card in front of a special RFID scanner who can charge your card quickly. The RFID chip can transmit a lot more information without having to dial in to a network. American Express says its ExpressPay transactions are 63 percent faster than using cash. I guess, if this technology works out, then the chip may be implanted in other devices like watches or cell phones (already available e.g. Nokia 6131 NFC) and who knows may be in the human body itself.

4) Citibank’s 2G Cards

The Citibank 2G cards are special cards that allow users press the request-rewards button before swiping the card for paying with their card points. The action of pressing the buttons changes the data imprinted on the magnetic stripe.

Check out the video for the demo of some of these cards

There are definitely lot of issues with the new technology that should be sorted before these become the de-facto credit cards. The key point for getting these technologically advanced cards relies in the adoption strategy by the millions of vendors who have already spent money for the infrastructure of today’s simple credit card. So they definitely would need some incentive to switch to advanced technology. Also the security is going to be utmost significance especially for contact less credit cards. I hope we see these soon in India, since I expect that these advance cards will bring more security to the end consumer.