Believe it or not, the big question about making a choice between home loan repayment and investments pop up at one or the other point of time. Increased salaries, revenues, business profits or a windfall income might instantly give rise to this dilemma. And to help you make a decision, it is important to tick-off few aspects first.
1) Interest earned vs interest saved - So, at one end, you are saving interest on a loan while on the other, you are earning interest on your investments. This makes it essential to analyse, which scenario is working in your favour.
Sample Case - Krishna has a home loan of Rs 50 Lakh for 25 years, where he is paying interest of 10% annually or Rs 45,434 as EMI. Krishna manages to save Rs 30,000 per month, which can either be used to prepay home loan or make fresh investments.
Scenario I - Krishna decides to invest Rs. 30,000 every month for next 25 years, i.e., equal to tenure of home loan, into a fund that fetches 12% per annum returns.
Scenario II - Krishna prepays home loan and is mortgage free after 12 years of loan tenure itself. He then invests Rs 75,434 per month (Home loan EMI + Surplus) in a fund delivering 12% p.a. returns for remaining period of 13 years of 25 years.
Now, let’s take a look as which scenario worked in Krishna’s favour.
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SIP/Investment Route
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Home Loan Repayment Route
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Corpus At The End |
₹ 5,63,65,398.79
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₹ 2,80,77,217.80
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The above illustration proves that Investment route clearly won over home loan repayment option.
2) Good debt vs bad debt - Needless to say, home loan qualifies as a good debt and so there should not be any haste in settling it down over other bad debts such as car loan or personal loan. While home value appreciates over time, home loan also attracts deduction under Income Tax Act, which should be a basis of taking any decision.
3) How close are you to Retirement? - If you are just 5 or 10 years away from retirement then prepaying home loan makes sense than investing. This is due to the fact that risk appetite diminishes with age and the equation explained in the above two scenarios reverses. Thus, home loan repayment is far better than investing in a fixed-income or debt fund.
4) What’s paid is paid - Prepaying home loan means that you lose the right to claim back the paid amount. On the other hand, investments into stocks and mutual funds are easily accessible and can be withdrawn if any unexpected event occurs. In short, sufficient cash flow as a backup can be a big advantage during unforeseen occurrences.
5) Still confused? Seek financial advisor’s help - While investments take precedence over home loan repayments, yet the decision is dominantly driven by an individual’s circumstances. Taking a call can be daunting at times as it is more than mere number-crunching. If you find yourself in such a situation then it’s only rational to reach out to a financial advisor to help it decipher it for you.
About The Author: Reenika Avasthi is associated with Inverika Investment Solutions LLP as a Content Writer and Financial Planner. She is a Certified Financial Planner and a freelance content writer in the field of personal finance. Her interest in writing and spreading investor awareness motivated her to start blogging.
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Very good analysis. However, the author has assumed 12% return arbitrarily. How can one be sure of this?
ReplyDelete12% returns are assumed based on average returns delivered by a diversified equity fund over the years. Analysis shows that large-cap funds with a history of more than 20 years have delivered trailing returns of 15% and more. But, 12% is assumed here using conservative approach.
ReplyDelete
ReplyDeleteThank you for sharing such great information.
It is informative, can you help me in finding out more detail on
is it better to prepay home loan.