This is now a tricky question for investors- Should you prepay your home loan amount or invest your surplus in mutual funds for returns? While considering this aspect, you should note that there are always two sides to every coin.
Many a time, investors have been left in a dilemma over investing surplus funds for prepaying their outstanding home loans or investing the same in mutual funds for future growth. What is the best possible solution? Here’s taking a look!
Prepayment of the home loan means paying the EMI installment prior to the due date. You can calculate the overall impact of paying a certain sum of money and how it will lower your current tenure. Prepayment is always a good option for borrowers since it helps in lowering the overall interest that you pay on the home loan. The interest portion is the highest in the initial home loan stages and if you are prepaying in the early years, then it will be hugely beneficial.
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SIPs or systematic investment plans are offered by mutual funds for enabling investors to make disciplined investments. Investors can allocate fixed sums of money at pre-fixed intervals in their chosen schemes. By choosing SIPs, they may invest for the long-term without worrying about short-term market fluctuations and changes in values. Some experts feel that investing in SIPs is a good option since home loan prepayment leads to higher expenditure and will not have any associated tax benefits.
Which One Should You Choose?
- If you wish to improve overall cash position and liquidity, then you can consider investing in debt mutual funds instead of prepaying your home loan right away. If you are seeking short-term liquidity, then equity funds are avoidable in this scenario. You may also switch or transfer your home loan to another lender or take a new smart-home loan or super-saver loan offering for holding spare funds in your home loan account.
- Remember that equity markets remain volatile with fluctuating returns. There will be ups and downs on a periodic basis and you should invest for the long haul only.
- If you prioritize paying off debt before taking up anything else and wish to get debt-free quickly, then prepayment is always a better option. You can plan to pay off your home loan in this manner over a certain period and then invest a higher surplus amount every month in mutual funds to make up for lost time as many experts advocate.
- If you have other financial priorities which are nearing their timelines, then you should invest in the same rather than prepaying your home loan right away.
- If you are in the early years of the home loan, then consider prepayment since you will save substantially on the interest cost. If you are nearing the last few years, then prepayment does not make much sense, since the EMI will majorly account for the principal component.
There is no one-size fits all formula that you can use in this regard. Here are some other scenarios that are worth considering if someone wishes to scale up the monthly EMI amount every month for swifter repayment of the home loan.
Scenarios That You Should Keep in Mind
Suppose someone comes to a new city for work and finds a job and then buys an apartment after spending a few years on rent. Let us suppose that this individual, Mr. A, has taken a loan of Rs. 80 lakh for 20 years at an interest rate of 6.70%. This means an EMI outgo of Rs. 60,592 per month. Suppose after taking this home loan, this individual has received a new promotion and three increments, moving up the career ladder and now has more cash in hand.
Mr. A is now naturally considering an increase in the monthly home loan EMI amount in order to prepay his loan faster. However, he is also eyeing an investment for future growth.
Decision 1- Mr. A goes with increasing the monthly EMI amount
Suppose for a period of 3 years or 36 months, Mr. A was paying Rs. 60,592 per month and the closing balance is Rs. 73,66,975 by the end of this duration. Now, taking a few aspects into mind is important-
Total loan amount- Rs. 80 lakh.
Amount payable in 20 years- Rs. 1,45,41,971.
Total amount paid (principal + interest) in three years- Rs. 21,81,312.
At the beginning of the 4th year, the principal amount pending is Rs. 73,66,975 as mentioned. Now, he reduces the tenure to 10 more years instead of 17 more years. Hence, the monthly EMI will be Rs. 84,402, i.e. Rs. 23,810 more than the monthly EMI being paid currently. The total interest outgo will be Rs. 27,61,281 for this period. Now, if you consider the total payment, it will be Rs. 1,01,28,256. Add the Rs. 21,81,312 paid already and you get a sum of Rs. 1,23,09,568.
This equates to savings of Rs. 22,32,403 in total interest costs. While Section 80C deductions may still be made up in a period of 7 years, the interest deduction under Section 24 will be missing. Hence, the net gain will be this savings amount subtracted from Rs. 14 lakh (Rs. 2 lakh per year in interest deductions under Section 24). This means a net gain of Rs. 8,32,403. Now, suppose he invests the entire amount of Rs. 84,402 for 84 months, i.e. the next 7 years of the loan that he has saved, then he will earn Rs. 1,11,39,291 on an investment of Rs. 70,89,768, i.e. meaning a net gain of Rs. 40,49,523. Add the earlier Rs. 8,32,403 to this and you get the final net profit of Rs. 48,81,926.
Decision 2- Mr. A choose to invest instead
Suppose that he pays the same amount over a specific tenure, paying Rs. 1,23,60,768 in his total home loan over the remaining 17 years. Instead, he invests Rs. 23,810 per month in SIPs at the same assumed annual return of 12% for a period of 17 years, i.e. 204 months.
He invests Rs. 48,57,240 and earns a total corpus of Rs. 1,59,03,195. This means a net gain of Rs. 1,10,45,955. Add Section 24 deductions to this and you get Rs. 14 lakh more, i.e. a total amount of Rs. 1,24,45,955. If you factor in the extra interest paid, i.e. Rs. 22,32,403, then you will still get a net gain of Rs. 1,02,13,552 which is more than the previous scenario.
Hence, as you can see, while option 2 seems to be better from a financial return point of view, you can still consider the option to get out of debt quicker, in order to ease your own scenario. However, without adopting a this or that approach, keep aside some money for mutual fund investments every month while prepaying your home loan EMI.
