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Saturday 27 October 2018

Home Loan Prepayment or Invest in MF

Interest rate moving northwards form last two three quarter in India. this situation create a discussion among the home buyers that whether they should prepay their loans to save on interest or invest the surplus in some other asset class which could yield better return than interest paid. Almost every salary earner who takes a housing loan faces it at some point. We take a loan at an EMI we can afford. Eventually, our income increases with time and now we find that we can pay back more of the loan than we had originally planned. In India, our psychology says debt is not good thing to have. We are more happy to repay the loan first. Keep this psychology aside and let try to answer this question with mathematics 

If ROI on your investment > home loan interest rate : Invest
If ROI on your investment < home loan interest rate : Prepay your loan.

Home loans are available at 8.5 to 9.5 percent rates. Whereas on the other hand, Mutual Funds generally grow at 12 to 14 percent annually.  Suppose there are two friend A and B. Both have surplus  rs35000 after their expenses. They have taken a home loan of 30,00,000 with ROI 9% for 20 years. A pays on pays only EMI and invest the remaining amount in MF (13% return). and B think other way. He decided to repay the loan quickly so he pays (EMI+10% of EMI) and invest the remaining amount in MF (13% return). And after completing Loan he would invest whole 35000 in MF. Here we have not taken the salary hike to keep the calculation simple. 

As we can see A will have Rs.9076138 and B will have only Rs.6195262. That means investment is better than repayment. While paying EMI, we get tax benefits under section 80C. So if you are in 20% slab of income tax than effective rate would be around 6.8% to 7.6%. and if we repay our loan then we have to pay additional income tax on EMI amount. This will reduce the corpus as well in the case of "B".

While answering this question we should not go by mathematics of ROI and tax. One should also see his risk profile. If some is not comfortable with equity investment then he can go with "B". B is also give less liquidity though out the tenure as well. One most of the important factor is the Time left on your earning life. Everyone have others financial goals like retirement planning, child education etc, which need to achieve with same salary. We can not postpone some of them. So if you divert your saving toward prepayment it may possible that you missed the other goals. 

Click here to download the sample file.

Hope this will help.

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