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A Detailed Guide on Whether You Should Invest or Prepay Your Home Loan

a detailed guide on whether you should invest or prepay your home loan

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Making financial decisions about whether to invest surplus funds or use them to prepay a home loan is a common challenge for homeowners. The dilemma revolves around the choice between potentially earning more through investments or reducing long-term debt by prepaying the home loan.

If you find yourself in a similar situation, grappling with the question of what to do with your extra funds, this article is personalized to help you navigate through the complexity.

Whether you lean towards investing or prepaying your home loan, the information presented here will guide you through the intricacies of each scenario, helping you make a decision that aligns with your unique financial goals and circumstances.


Continue reading to understand the detailed situation and equip yourself with the knowledge needed to make a more confident and effective financial choice.

Understanding the Basics of Investing/ Prepaying Home Loan

Pros of Investing

  • Potential for higher returns: Investments in stocks, bonds, or mutual funds can offer significant returns over time.
  • Diversification: Investing allows you to spread your risk across different assets, reducing the impact of a single investment’s poor performance.

Cons of Investing

  • Market risks: Investments are subject to market fluctuations, and there’s always the potential for loss.
  • No guaranteed returns: Unlike prepaying a home loan, investment returns are not assured.

Pros of Prepaying Home Loan

  • Interest savings: prepaying your home loan reduces the outstanding principal, resulting in interest savings over the loan tenure.
  • Guaranteed return: The interest saved is a guaranteed return on your money.

Cons of Prepaying a Home Loan

  • Opportunity cost: The funds used for prepayment could potentially have earned higher returns through investments.
  • Liquidity reduction: prepaying ties up funds that could be needed for emergencies.

A Detailed Case Study: Investing or Prepaying Home Loan

General Context of the Study

Mrs. Kavita, a working professional, currently finds herself in a dilemma, unable to decide how to utilize the extra money she has received as a bonus from her company. Faced with two options, she must choose between accelerating her home loan repayment or investing the surplus funds. This decision is crucial for her financial well-being and peace of mind.

To determine the best course of action, let’s analyze the details to help Kavita make an informed and confident decision for her financial future.

Scenario 1: Kavita Chooses to Accelerate Loan Repayment

Kavita decides to expedite her home loan repayment by increasing the EMI to Rs. 1.2 lakh per month for the next 12 years.

Let’s analyze the financial details:

Reduced Tenure Analysis

DetailsAmount (INR)
Original Loan Amount1.5 crore
Total Amount to be paid in 25 years3.6 crore
Initial EMI95,000
Total paid in 48 months45.6 lakh
Principal Amount at the end of 4th year1.35 crore
Reduced Tenure (after 4 years)12 years
New EMI amount1.2 lakh
Amount paid in 12 years1.73 crore
Total paid in 16 years2.19 crore
Interest Amount Saved1.41 crore

Loss of Tax Benefits due to Early Repayment

DetailsAmount (in INR)
Tax Bracket25%
Tenure8 years
Forgone Tax Benefit15.75 lakh

Additional Returns if EMI Diverted to SIP after Early Closure

DetailsAmount (in INR)
SIP investment per month1.2 lakh
Tenure8 years
Average annual returns10%
Total Corpus after 8 year1.5 crore
Returns earned60.6 lakh

Total Benefit/Gain from Early Closure

DetailsAmount (in INR)
Returns Earned60,60,000
Interest Amount Saved1,41,00,000
Tax Benefit Foregone-15,75,000
Total Gains86,35,000

Scenario 2: She Chooses to Invest Surplus Amount

Now, Kavita has decided to maintain the original EMI but invest the surplus ?45,000 from the fourth year. Let’s evaluate the outcome:

Investment Analysis

DetailsAmount (in INR)
SIP investment per month45,000
Tenure21 years
Average annual returns12%
Total Corpus after 8 years3.2 crore
Returns earned2.35 crore

Additional Tax Benefit if She Sticks to Original Tenure

DetailsAmount (in INR)
Tax bracket considered25%
Additional interest paid in 12 years1.41 crore
Additional Tax Saving under Section 2415.75 lakh

Total Benefit/Gain by Continuing the Loan

DetailsAmount (in INR)
Returns earned by investing1.2 lakh
Total taxes saved in the last 12 years10%
Extra interest paid for the home loan-1.41 crore
Total Gains2.09 crore

The Verdict: Continuing the Home Loan and Investing Extra Amount is a Better Option

In this altered scenario, choosing to invest the surplus amount rather than closing the loan early results in a higher gain of Rs. 2.09 crore compared to the gain of Rs. 86.35 lakhs from early closure. This emphasizes the significance of carefully considering both investment returns and tax implications in making informed financial decisions.

Key Takeaways of the Analysis at a Glance

FactorsInvestment PerspectivePrepayment Perspective
Higher returnsThe investment scenario yielded a profit of ?2.09 crore after twelve years.Guaranteed return: Kavita secured a guaranteed return through interest savings.
FlexibilityKavita has liquidity and can access the invested amount if needed.Reducing debt can provide financial peace of mind.
Market risksIf the Indian market had performed poorly, Kavita could have faced losses.The foregone investment returns could have been higher.

Considering Investments vs. Home Loan Prepayment: What You Must Do?

When faced with surplus funds, homeowners often contemplate whether to invest the money or use it to prepay their home loan. 

You must consider the following aspects:

  • Interest Rates on Investments: If the potential returns from your investments are expected to be higher than the interest rate on your home loan, it may be more logical to invest the surplus funds, capitalizing on higher investment returns.
  • Tax Benefits: Evaluate tax implications, considering benefits associated with both home loan repayment and certain investments. Some investments offer tax advantages that can enhance overall returns, making them more attractive than prepaying a home loan.
  • Diversification: Diversify your portfolio as a fundamental principle of investment. Instead of concentrating all resources on repaying a home loan, spreading risk through investments can potentially yield better long-term results.
  • Emergency Fund and Liquidity: Maintain an adequate emergency fund before allocating funds to either prepaying a home loan or investing. Liquidity is crucial for unforeseen expenses and financial security.
  • Financial Goals: Align your investment decisions with your financial goals. If long-term wealth creation is a priority, investing may align better; however, if debt reduction and financial security are paramount, prepaying the home loan may be the preferred option.

Want to Prepay Your Home Loan? – Look No Further Than Credit Dharma

Credit Dharma empowers you to explore financial solutions that transform your aspiration of real estate ownership into a tangible reality. Offering expert guidance and impartial advice on home loans, the Credit Dharma team, known for its exceptional customer service, assists in enhancing your home loan eligibility. This ensures you qualify for the most advantageous mortgage terms.

What happens when you apply for a home loan with Credit Dharma?

Credit Dharma is committed to prioritizing your dreams of home ownership through a seamless and efficient Home Loan application process. Our comprehensive services cover everything from securing the best rates to simplifying paperwork, ensuring a transparent and hassle-free experience.

Simplifying Home Loans with Credit Dharma

With Credit Dharma, you can optimize your savings on home loans, attain quicker loan freedom, and benefit from a one-stop solution for all your housing finance needs.

  • Competitive Home Loan Interest Rates: Enjoy the advantage of low-interest rates starting at 8.4% p.a., helping you reduce the overall cost of your Home Loan.
  • Swift Loan Disbursal: Experience faster loan disbursal, ensuring you can proceed with your home plans without unnecessary delays.
  • Lifetime Support: Benefit from free lifetime support; our dedicated team is always ready to assist you at every step of your home loan journey.
  • Spam-Free Experience: Rest assured, at Credit Dharma, your privacy is valued. You’ll never have to worry about spam or unwanted communications.

You can check out Credit Dharma’s home loan eligibility calculator to determine the loan amount you qualify for based on your income.

Here is a table summarizing the top home loan bank partners with their respective interest rates and maximum tenures:

Bank PartnerInterest Rate RangeMaximum Tenure
SBI Home LoanFrom 8.40% p.a.Up to 30 years
BOIFrom 8.45% p.a.Up to 30 years
Bajaj FinanceFrom 8.45% p.a.Up to 40 years**
Kotak Mahindra BankFrom 8.75% p.a.Up to 20 years
LIC HFLFrom 8.45% p.a.Up to 30 years
HDFC Home LoanFrom 8.45% p.a.*Up to 30 years
Axis BankFrom 9.00% p.a.Up to 30 years
ICICI Bank8.40% – 9.45%Up to 30 years
L&T FinanceFrom 8.60% p.a.Up to 25 years
PNBFrom 8.50% p.a.Up to 30 years
Note: The interest rates and maximum tenures are subject to change, and it’s advisable to check with the respective banks for the most current information.

Conclusion

The decision to invest or prepay a home loan depends on individual risk tolerance and financial goals. Investors seeking higher returns may opt for investments, while those prioritizing guaranteed returns and reduced debt may prefer prepayment.

A balanced approach, such as allocating a portion to investments and the rest to debt reduction, may suit some individuals. In the end, you must consider individual circumstances, risk appetite, and long-term financial objectives when making this decision. To consult with a financial advisor you can schedule a demo with the Credit Dharma expert team.

FAQs

Why should I consider prepaying my home loan?

Prepaying your home loan reduces the outstanding principal, resulting in interest savings over the loan tenure. It provides a guaranteed return and helps in reducing long-term debt.

Are there risks associated with investing compared to prepayment?

Yes, investing comes with market risks. If the market performs poorly, you could face losses. prepayment, on the other hand, provides a guaranteed return but foregoes the potential for higher returns from investments.

Should I review my decision periodically?

Yes, it’s advisable to review your financial situation periodically and adjust your strategy based on changing goals, market conditions, and personal circumstances. Regular reviews with a financial advisor can help ensure your approach remains aligned with your objectives.

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