Investment vs Loan Prepayment Calculator

10 minutes

The Investment vs Loan Prepayment Calculator is an essential financial tool designed to address a prevalent financial quandary: whether it is more beneficial to invest surplus funds or to prepay loans early. At its core, this home loan prepayment vs investment calculator compares the potential returns from investments with the interest savings from prepaying a loan.

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Investing vs Prepayment

Investing

Pros:

• Higher Returns: Investing can offer higher returns compared to the interest rates on your debt, especially if you invest in stocks or mutual funds over the long term.
  
• Compounding Interest: Your investment earnings can generate their earnings over time, potentially increasing your wealth significantly.
  
• Tax Benefits: Some investments, like retirement accounts, offer tax advantages that can enhance your returns.

Cons:

• Market Risk: Investments can be volatile and lose value, especially in the short term. There’s no guarantee of returns, unlike the guaranteed ‘return’ of saving on loan interest.
  
• Complexity: Investing wisely requires research and ongoing management, which can be daunting for some.
  

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Loan Prepayment

Pros:

• Peace of Mind: Paying off debt, especially high-interest loans, can provide a sense of financial freedom and reduce stress.
  
• Guaranteed Return: Eliminating debt guarantees a return on your money equal to the loan’s interest rate. If your loan has a 5% interest rate, every dollar you pay toward the principal saves you 5% in future interest.
  
• Improved Credit Score: Reducing your debt can improve your credit score by lowering your credit utilization ratio, which can be beneficial for future borrowing.

Cons:

• Less Liquidity: Using extra cash to pay off debt means you’ll have less money available for emergencies or other investment opportunities.
  
• Opportunity Cost: You might miss out on higher returns from potential investments, especially if your loans have low-interest rates.

Investing vs Prepayment: Case Study

When securing a home loan, we carefully align our choice of monthly payments with our current financial landscape. Yet, as our earnings evolve, we’re often greeted with a compelling crossroads: the decision to either expedite the journey to becoming mortgage-free by prepaying our home loan or to potentially amplify our wealth through investing in mutual funds.

Ramesh has completed his B.TECH degree from a known engineering college, and after 10 years of work life in Mumbai, he decided to buy a house. With the high cost of houses in Mumbai, he had but one choice which was to get a home loan. But as he grew older, his salary increased and now he is in a dilemma – whether to prepay his loan or invest the extra money. Ramesh had been paying an EMI of Rs 1,16,300 on his loan of 1.5 crores for 20 years.

Scenario 1

Increase in EMI

After 3 years, Ramesh got a promotion and his salary increased. So he decided to increase his EMI by Rs 50,000 so as to decrease his tenure. Now he has to pay Rs 1,66,300 each month.

Increased EMI	Amount
Total loan	Rs 1.5 crore
Total amount to be paid back in 20 years	Rs 2.8 crore
EMI amount	Rs 1.16 lakh
Amount paid in 36 months	Rs 41.9 lakh
Opening balance on 4th year	Rs 1.38 crore
Tenure decreased (after 3 years)	115 months
New EMI amount	Rs 1.66 lakh
Amount to be paid to Bank in 115 months	Rs 1.91 crore
Total Amount Paid in 13 years (Approx)	Rs 2.33 crore
Total Interest Amount Saved	Rs 46 lakh

Therefore, Ramesh saves Rs 46 lakhs on increasing his EMI, according to the hdfc home loan prepayment rules.

Loss of Tax Benefits

Under income tax regulations, Ramesh is eligible for a tax deduction of up to Rs 1.5 lakh on the principal repayment annually under Section 80C.

Moreover, he can claim a deduction up to Rs 2 lakh for the interest paid on the home loan each year under Section 24.

However, by choosing to repay his loan prematurely, he will miss out on these tax benefits.

Although Section 80C provides various avenues for tax savings, Section 24 benefits are exclusive to the interest component of home loans. Thus, it’s assumed that Ramesh will relinquish the advantages offered by Section 24.

Tax Benefits Lost	Amount
Tax bracket	30%
Tenure (approx)	7
Tax Saving he won’t be able to claim	Rs 10.5 lakh

Returns if EMI is Diverted to SIP After Early Closure

Imagine that, once his home loan is fully repaid, he opts to channel the funds previously allocated for his home loan EMI into mutual funds via SIPs (Systematic Investment Plans). We’ll explore the potential size of the investment corpus he could build over the next seven years.

SIP Investments	Amount
Amount Invested per month	Rs 1.66 lakh
Tenure(months)	89 months
Average Annual Returns	12%
Total Corpus at the end	Rs 2.39 crore
Return	Rs 91 lakh

So he gets a return of Rs 91 lakhs. The hdfc loan part payment did benefit him with the additional investment returns.

Total Benefit/Gain if He Closes the Loan Early

Now, by adding the investment returns, the amount saved on interest by settling the loan early, and subtracting the forfeited tax advantages, his total financial benefit from closing the loan ahead of schedule amounts to Rs 1.27 crore.

Total Gains	Amount
Return by SIP	Rs 91 lakh
Amount saved as home loan interest rate	Rs 46 lakh
Tax benefit lost	Rs 10.5 lakh
Total gains	Rs 1.27 crore

Scenario 2

Invest

Let’s imagine Ramesh decides to maintain the agreed upon EMI for the entire loan term, but starting in the fourth year, he plans to invest an extra amount, say Rs 50,000, instead of increasing his EMI payments. We will now assess the size of the investment fund he could potentially accumulate following this approach.

SIP Investments	Aspects
Amount Invested per month	Rs 50,000
Tenure(months)	204 months
Average Annual Returns	12%
Total Corpus at the end	Rs 3.34 crore
Return	Rs 2.32 crore

By allocating Rs 50,000 towards investments for 17 years, he’ll build a fund worth Rs 3.34 crore, with the earned returns amounting to Rs 2.32 crore. Meanwhile, he benefits from the hdfc home loan prepayment limit without missing any tax deductions.

Additionally, invest home benefits are retained while repaying the home loan.

In this scenario, he will also retain his eligibility for tax deductions throughout the 20-year loan period. Let’s explore the additional tax savings he would accrue during the extended 7 years of his loan’s lifespan.

Tax Benefits Lost	Amount
Tax bracket	30%
Total additional interest he will be paying	Rs 46 lakh
Additional Tax Saving under Section 24	Rs 10.5 lakh

Total Benefits/ Gains

Now, by adding together the investment returns and the extra tax savings, then subtracting the additional interest payments made to the bank, he will net around Rs. 1.96 crore.

Total Gains	Amount
Return by SIP	Rs 2.32 crore
Total amount of taxes saved	Rs 10.5 lakh
Extra interest you pay for the home loan	Rs 46 lakhs
Total gains	Rs 1.96 crore

The Final Verdict

From the calculations presented, if Pranay opts to settle his loan earlier, he stands to gain Rs. 1.27 crore. On the other hand, choosing to invest could elevate his total earnings to Rs 1.96 crore.

This significant difference stems from two key factors:

• Mutual funds, particularly equity mutual funds, have the potential to yield higher returns over the long term compared to the interest charges on a home loan, even though their returns aren’t guaranteed.
• The real benefits become evident only after accounting for tax savings. Especially for those in higher tax brackets, the savings from tax deductions can be substantial.

Nonetheless, it’s crucial to note that these outcomes are contingent on consistently investing and scaling up investments in line with salary increments. Misallocating additional income towards lifestyle upgrades instead could jeopardize this financial strategy.

Making the Decision: Invest or Prepay?

The decision to invest or prepay your loan depends on several factors, including the interest rate of your loan, the expected return on your investment, your financial goals, and your risk tolerance.

Generally, if the expected return on investment is higher than the loan’s interest rate, investing might be the more lucrative option. However, paying down debt offers a guaranteed return in the form of interest savings, which is particularly appealing if you’re risk-averse or prioritizing financial stability.

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How to Use the Investment vs Prepayment Calculator

Here’s a simple step-by-step guide:

1. Input Loan Details: Start by entering the specifics of your loan, including the loan amount, current EMIs, and loan tenure.
   
2. Completed Tenure: Enter the number of years you have already repaid the loan.
   
3. Extra EMI Amount: Choose the amount of additional EMI you plan to put up
   
4. Hit Calculate: Once all the information is in, press the calculate button to see the magic happen. The calculator will display the potential future value of your investment versus the interest saved by prepaying your loan.
   

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Conclusion

Deciding whether to invest home or prepay loans depends on several factors, including the interest rate of your loan, the expected return on your investment, your financial goals, and your risk tolerance. Home loan prepayment with calculator provides useful insights to make an informed decision.

Still unsure about how to do prepayment of hdfc home loan? Use our home loan prepayment calculator or consult our experts. Credit Dharma Experts!

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Frequently Asked Questions