Home Equity Line of Credit

I really don't know much about this, but this is a topic of much wider interest, so I am writing about this.

A Home Equity Line of Credit (often called HELOC, pronounced HEE-lock) is a loan in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower's equity in his/her house.

A HELOC differs from a conventional home equity loan in that the borrower is not advanced the entire sum up front, but uses the line of credit to borrow sums that total no more than the amount, similar to a credit card. At closing you are assigned a specified credit limit that you can borrow up to. During a "draw period" (typically 5 to 25 years), HELOC funds can be borrowed "on demand" and you pay back only what you use plus interest. Depending on how much you use the HELOC, you will have a minimum monthly payment requirement (often "interest only"); beyond the minimum, it is up to you how much to pay and when to pay. At the end of the draw period, you will have to pay back the full principal amount borrowed either in a lump-sum balloon payment or according to a loan amortization schedule.

Another important difference from a conventional loan: the interest rate on a HELOC is variable based on an index such as prime rate. This means that the interest rate can - and almost certainly will - change over time.

HELOC loans have become very popular in the United States in 2000s, in part because interest paid is typically (depending on specific circumstances) deductible under federal and many state income tax laws. This effectively reduces the cost of borrowing funds. Another reason for the popularity of HELOCs is the flexibility not found in most other loans - both in terms of borrowing "on demand" and repaying on a schedule determined by the borrower. Furthermore, HELOC loans' popularity growth may also stem from their having a better image than a "second mortgage," a term which can more directly imply an undesirable level of debt.

It must always be kept in mind that the underlying collateral of a home equity line of credit (HELOC) is the home. This means that failure to repay the loan or meet loan requirements may result in foreclosure.

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Mutual Funds Simplified

Equity markets may have rebounded smartly after the dramatic fall in May. But fixed-income instruments seem to be stealing the show these days.
After wrecking havoc in stock markets around the world, the tight liquidity scenario is finally playing to small investors' advantage. After several years, investors are finding that fixed deposit rates are climbing to respectable levels.
While 90-day bank deposits are offering around 5 per cent returns, one-year deposits are yielding 7-8 per cent. As far as mutual funds are concerned, though the future of income funds, which invest in medium-and long-term debt papers, seems to be uncertain, short-term debt funds are giving returns in excess of 6.5 per cent.
On a post-tax basis, debt schemes - fixed-maturity plans in particular - seem to be the best option for investors looking for steady returns.

Funds beat banks: Even as banks are luring investors with higher fixed-deposit rates, mutual funds seem to be steeling a march over them with FMPs. The total assets under management under these schemes have nearly doubled this year.
At the end of July, these schemes had a combined corpus of Rs 28,571 crore (Rs 285.71 billion). According to industry sources, in August alone, 14 FMPs have so far been launched with varying maturity and the total collection is expected to be at least around Rs 4,000 crore (Rs 40 billion).
The AMCs that have launched FMPs this month include Reliance, ABN AMRO, Principal, HSBC, UTI, HDFC, LIC, Prudential ICICI, JM Financial, DBS Chola and SBI.
Essentially targeted at corporate and high net worth investors, FMPs combine the tax efficiency of mutual funds with the safety of fixed deposits.
The current rates on FMPs are as attractive as bank deposit rates and, thanks to the lower taxes on mutual funds, the post-tax returns on FMPs are better.
Currently, 90-day FMPs are offering around 6.85-7.10 per cent, while one-year FMPs are generating around 8.10 per cent pre-tax returns. HDFC Mutual's 26-month FMP yields 8.45 per cent for corporate investors and 8.10 per cent for retail investors.
These schemes usually come with a quarterly or annual term, and the shorter-term schemes are a huge hit with corporate investors, who usually seek to lower the tax incidence.
Mutual funds charge as low as 5-10 basis points as expenses, which is abysmally low. Even for retail investors in the top income tax bracket, these schemes make sense.

The tax edge: As dividends of mutual funds attract only a dividend distribution tax of 22.44 per cent for corporate and 14.03 per cent for individual investors vis-�-vis interest on deposits and corporate bonds, charged at the marginal income tax rate, mutual funds give better post-tax returns.
"High net worth individuals have a lot of appetite for these schemes as they generate significantly higher post-tax returns," says Sameer Kamdar, national head - mutual funds, Mata Securities.
Furthermore, income from mutual fund units - held for more than a year - is deemed to be 'capital gains' and, hence, qualifies for indexation benefit. This reduces the tax incidence even more.
Thus, while a 8.1 per cent, one-year FMP would yield a post-tax return of 7.2 per cent for an individual investor in the top income tax bracket (if he opts for the growth plan), a bank fixed-deposit offering a similar rate would yield only 5.37 per cent net of tax.
Even if you opt for the dividend plan, which is less tax-efficient compared to the growth plan, for more than one-year time horizon, you would come up with a post-tax return of 6.96 per cent.
The post-tax returns indicated above are based an indexation rate of 4.5 per cent. For the uninitiated, indexation is a method wherein returns are deflated to the extent of inflation.
The tax is calculated only on the inflation index-adjusted returns. The idea is that tax on long-term capital gains must be charged only on the real returns earned by an investor. The inflation index is published by the income-tax department every year.
Similarly, 90-day FMPs, which offer 7 per cent, would yield a post-tax return of 6.01 per cent. Currently, JM Mutual and LIC are offering rates upwards of 7 per cent.

The risk factor: Though FMPs are projecting fairly high yields, these are only indicative returns. They produce predictable returns over the desired timeframe since the maturity of the portfolio matches the tenure of fund schemes.
Unlike other schemes that suffer from volatility and, hence, risk of erosion in asset value, an FMP - structured as closed-end funds - carries no interest rate risk. Whether yields rise or fall, the asset value of these schemes is protected as deposits/ bonds are held to maturity.
Still, they do not guarantee returns as bank deposits - where the interest is assured - do. Though FMPs have delivered the returns they have indicated so far, there could be a risk of asset-liability mismatch, and the investor may not finally get exactly the indicated yield.
Says Dhirendra Kumar, chief executive officer of Value Research, a Delhi-based mutual fund tracking firm, "Since there is no guarantee on the returns that funds give, there is a risk that investors may or may not eventually get the returns indicated even in case of FMPs, which are otherwise quite predictable."
Besides, if you lock in funds in an FMP you don't have the option of liquidating it prematurely. But in case of bank deposits, you can withdraw your money without any penalty. However, the interest rate you earn on the deposit would be based on the period the money is invested for.
For instance, if you break a one-year deposit after three months, you would be entitled to the interest rate applicable for the three-month deposit - and not the one-year rate.
In fact, since bank deposits can be withdrawn without any penalty, it is an ideal time for investors to close their old deposit accounts yielding lower returns and renew them at the prevailing rates.

Other debt funds: With uncertainty on interest rates receding, debt markets have rallied over the past one month. The 10-year benchmark yield has declined from 8.5 per cent in mid-July to 7.91 per cent now, and this has propped up the returns on debt fund schemes.
Most categories of debt funds have delivered returns in excess of 6 per cent. Particularly, medium-term gilt and debt funds have generated over 10 per cent returns. Should you then begin to relook at income funds?

May be, not yet.

Fund managers warn that this kind of returns may not be sustainable. On the contrary, the debt market rally looks overdone and the market may be in for some correction.
And if that happens, income funds may be back to square one. Moreover, the risk-return factor, today, is strongly in favour of short-term funds.
"The return differential between medium-term and short-term debt funds is quite narrow, and the choice must be obvious given that short-term funds offer far greater stability and slightly lower returns," says Kumar.
Over the past one-month, short-term funds have seen a surge in returns too. This category has given an average return of 7.2 per cent, which again compares favourably with bank deposits on a tax-adjusted basis.

Source & Help: www.rediff.com

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How to secure your child's future

Though insurance is ideally seen only as a "protection tool", many investment-oriented products from insurance firms have caught the fancy of investors.
Child insurance plan is one among them. These are promoted as ways that help parents fund their children's needs such as education and marriage. Usually under such plans, the parent is the insured person and the child is the beneficiary.

The two broad categories of Child Plans are:
Traditional plans such as endowment plans or money back plans: The proceeds from these may either be in lump sum (as in endowment) or as installments over a number of years (as in money back plans).
Here, the proceeds will have two parts: (a) The basic sum assured which is payable to the beneficiary either on policy maturity or on the death of the insured. (b) The bonus component, which depends on the amount declared by the insurance company each year, is accumulated over the years and is paid out at in the final year.
The premiums received under these plans are invested in debt instruments such as government bonds. Such policies are easy to understand. However, as they lack equity component, they do not really serve the purpose of creating wealth in the long term.
Unit linked plans: These policies became popular recently. The premiums received herein are invested in equity and/or debt markets, depending on the policyholder's preference. Here, there is usually no guaranteed bonus on the part of the insurance company and the entire investment risk is borne by the policy holder.

Benefits of ULIPs Vs traditional policies
There are two major benefits for ULIPs:
Charges and portfolio disclosures are transparent in the case of ULIPs.
A policyholder has greater flexibility in choosing the investment options compared with traditional policies. Switching between options is also possible.

ULIPs Vs diversified mutual funds
So how do these policies fare compare with mutual funds? After all, investing in these policies means that you are believing that they are an adequate substitute to mutual funds. This is what I found:
These policies are far more opaque compared with MFs. The Web sites of two of the leading insurance companies (HDFC and ICICI Prudential) contain data up to September 30, 2006, only and not beyond, as they only undertake quarterly declarations. Compared with this, most MFs declare performance data on a daily basis and their portfolios at least once a month.
The charge structure in insurance policies is complicated (as I have outlined above) compared with those of MFs where the maximum charges levied rarely exceed around 4.50-5 per cent. While some defenders of child plans may state that the charges reduce with time, it also means that the policyholder is compelled to stay with a poorly performing fund merely because he has already paid the lion's share of expenses at the outset of the policy.

Returns
On the returns front, a comparison is difficult as ULIPs have been functioning for only around the past three years, unlike most of the well managed diversified equity funds which have been around for much longer.
However, certain stipulations on the part of the Insurance Regulatory and Development Authority (such as the seven-year dividend payout rule) constrain the investment universe for insurance companies. Hence they may not be able to exploit many investment opportunities, unlike mutual funds who can do so.
If one takes a couple of examples, HDFC Standard Life Growth Fund (ULIP) has given a return of 1100 basis points per annum over its benchmark (BSE-100) since January 2005 (as per their Web site) while Pru ICICI Maximiser has outperformed the benchmark by around 500 basis points since inception.
Compared with this, HDFC Growth Mutual Fund's returns stood at around 700 bps over the BSE Sensex while ICICI Growth Plan has given returns of around 1200 bps over the NSE Nifty Index. It will be interesting to see how the insurance companies perform during difficult times.
Traditional policies need not be considered as competition, as most, if not all, have given single-digit returns over time.

The final word
There is no conclusive evidence to show that Child Plans are superior for wealth creation. Till such evidence is obtained, I believe that it is preferable to unbundle the insurance and investment activities.
Hence I will end by once again suggesting that a combination of a term policy plus a systematic investment plan in a good diversified equity fund will serve our purpose in a superior way.

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