Can step-up EMI help you create wealth via MFs?

It is ironical to know that when it comes to debt there are people who are continually relying on credit and there are people on the other part of the spectrum who wish to get rid of this burden as soon as possible. So, is taking credit a bad thing? No, not at all. Taking credit is not a bad thing, but taking credit more than your capacity is a bad thing. Taking credit for your core needs is understandable. However, taking credit by leveraging a large part of your income doesn’t help you in creating wealth. Except for your first home or first car or say child education, avoid taking credit or you may take credit which doesn’t exceed 30 per cent of your income.

Now the question is how step-up EMI (Equated Monthly Instalments) can help you in creating wealth? Let us take an example to understand in a much clearer way. Let us assume that you take up a loan of Rs. 20 lakhs at the rate of say 10 per cent for 15 years by paying EMI of Rs. 16,119 per month for 15 years and your total monthly investible surplus or savings is Rs. 30,000. We also assume that you would invest the remaining investible surplus at the rate of 10 per cent. Now let us assume that you, step-up your EMI by 5 per cent every year. This means that in the first year you will pay EMI of Rs. 16,119 per month, in the second year you will pay EMI of Rs. 16,925 per month, in the third year you will pay EMI of Rs. 17,771 and so on. This will help you in paying back your loan early by two years. That means your loan will end in 13 years and in the thirteen's year you would be paying EMI of Rs. 28,947 per month.

So, at the end of 15 years with step-up EMI you are able to accumulate Rs. 2.76 crore. You must be thinking that is a huge number. However, what if you didn’t go with the step-up EMI? If you didn’t go with the step-up EMI then you are able to accumulate Rs. 3.6 crore, which is more than what step-up EMI is able to accumulate. Now, you may ask why step-up EMI is not creating wealth? The reason for the same is that as it nears the step-up EMI term, 13 years in our case its EMI goes on increasing and investment goes on decreasing every year, though in the final two years you are able to invest the whole surplus of Rs. 30,000 you only have two years to grow, this doesn’t help much. However, when you are not opting for step-up EMI you are able to maintain the same amount of investment throughout the year and able to cherish the magic of power of compounding. So, it won’t be a good idea to go for step-up EMI to create wealth, rather a step-up SIP would better to create wealth.