Decision making can be tedious when multiple options are available. Financial decisions always seem the most difficult ones to make. In the era where home loans are available at such cheap interest rates, one can easily get a loan to buy or build a home.
Building or buying a home is more of an emotional choice and it can hardly be influenced by anyone. With home loans being available at cheap rates and rising equity markets, one would be struggling with the decision of buying a home, repayment of a home loan or investing in the equity market. If one had surplus money in hand, what would they do? Invest in mutual funds or repay an existing loan or invest in property?
Investing in property vs investing in other investment products (equity)
Investing in a home would mean an opportunity cost analysis has to be done. You would invest lump sum right now plus a regular payout in the form of EMI should be made. You have to compare the cost of this against the return you will get against investment in any other investment product. If the return from investing in equity is higher than the return from the property you get after deducting the cost of maintenance and cost of interest and adding the rent (if any) from the property.
Home Loan Prepayment vs Investment in Mutual Funds
A bonus amount received from the employer might seem a good opportunity to prepay a part of your loan. This means the tenure of your home loan can come down by 2-3 years. But is it a feasible option? Interest payments up to Rs 2,00,000 are eligible for tax deduction under section 24. Investment in mutual funds can help you to reduce the loan tenure as well. Let’s not believe it blindly, instead let’s see an illustration for the same.
Let’s say there is a home loan of Rs 75,00,000 taken in the year 2014. The interest rate in the market now is 9%. The EMI is Rs 67,479 and the loan will mature in 2033 December.
Scenario 1: You prepay a part of the loan of Rs 7, 00,000 in Jan 2018. This will reduce your loan tenure by 3 years and you will be debt free in the November 2030.
Scenario 2: You invest Rs 7,00,000 in Jan 2018 in equity mutual funds. Let’s say you get a decent interest rate of 12%. You will be able to pay off your loan by 2029 December. Here it is assumed that you will close the loan once the investment amount is equal to the outstanding loan.
|Scenario||Prepayment / Investing||Loan Tenure|
|Scenario 1||Prepayment of loan||November 2030|
|Scenario 2||Investing in Equity @ 12%||December 2029|
Factors to Consider
One’s decision shouldn’t solely depend on numbers. There are various other factors that affect this decision. They are:
- Emotional State: Is being in debt bothering you? Will being debt free make you happy? Then you are better off paying the loan.
- Risk capacity: Equity markets are volatile and the returns from them fluctuate highly and there will be a period of negative returns. One should be patient enough with them and a minimum investment period of 7 years is suggested.
- Other financial goals: Having other financial goals with tenures being close by, it’s better to invest more in those goals than prepaying a loan.
- Liquidity: If you want to improve your liquidity then it’s better to invest in debt mutual funds than prepaying a loan. In case you are looking for short-term liquidity then equity funds might not be an option for you. You might also look at moving your home loan into a super-saver or smart home loan kind of structure where the spare funds can be held in the home loan account. This will reduce the interest on the home loan while providing you with liquidity at the same time, with a rate of return equivalent to the rate of the home loan. If you have a major goal coming up in less than five years, you may want to look at debt mutual funds for investing your money.
After considering the above factors make an informed decision. So, as you can see that choosing a prepayment of a home loan over a investment in mutual funds or vice versa cannot be an ideal decision for everyone. It depends on individual circumstances and should be dealt differently.
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