10 minutes
Managing finances is a critical part of building wealth. When you have a home loan and surplus funds, you’re often faced with a dilemma: Should you use the extra money to prepay your home loan or invest it for better returns? This guide will walk you through everything you need to know about home loan prepayment vs investment and introduce you to Credit Dharma’s proprietary calculator that simplifies this decision-making process.
Investing vs Home Loan Prepayment
Investing
Investing involves allocating your surplus funds into financial instruments like mutual funds, SIPs, or equities to grow your wealth over time.
| Pros of Investing | Details |
|---|---|
| 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 own earnings over time, potentially increasing your wealth significantly. |
| Tax Benefits | Some investments, like retirement accounts, offer tax advantages that can enhance your returns. |
| Cons of Investing | Details |
|---|---|
| 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. |
Suggested Read: Real Estate Investment Trusts (REITs)
Home Loan Prepayment
Home loan prepayment involves paying an additional amount over your regular EMI to reduce the principal. This can significantly shorten the loan tenure and reduce the total interest paid.
| Pros of Paying off Debt | Details |
|---|---|
| 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 of Paying off Debt | Details |
|---|---|
| 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. |
Also Read: Is real estate a better investment than the Stock Market?
Use the home loan prepayment calculator to find out if a home loan is right for you and get expert advice.
Investing vs Prepayment: Case Study
Ramesh, a B.Tech graduate from a reputable engineering college, worked in Mumbai for 10 years before deciding to buy a house. Given the high property prices in the city, he took a ₹1.5 crore home loan with an EMI of ₹1,16,300 over 20 years. As his salary increased with time, Ramesh now faces a dilemma: whether to prepay the loan and become debt-free sooner or invest his extra income to grow his wealth.
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.
Loss of Tax Benefits
- Under Section 80C, Ramesh is eligible for a tax deduction of up to ₹1.5 lakh annually on the principal repayment of his home loan.
- He can also claim a deduction of up to ₹2 lakh per year on the interest paid under Section 24.
- Prepaying the loan prematurely will result in Ramesh losing these tax benefits.
- While Section 80C offers other tax-saving options, Section 24 benefits are exclusive to home loan interest.
- By prepaying, Ramesh forfeits the unique advantages provided 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 |
Suggested Read: Real Estate Growth in India’s Tier 1 and Tier 2 cities
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.
Check Out: Home Loan Prepayment Calculator
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 |
Get a Home Loan
with Highest Eligibility
& Best Rates
The Final Verdict
Based on the numbers, if Ramesh decides to pay off his loan early, he could save ₹1.27 crore. But if he chooses to invest instead, his total earnings might grow to ₹1.96 crore—a significant difference!
This boils down to two main reasons:
- Mutual funds, especially equity ones, typically offer higher long-term returns compared to home loan interest, even though the returns aren’t guaranteed.
- The real game-changer is the tax savings. For those in higher tax brackets, the deductions can make a big difference.
That said, these results depend on staying disciplined—investing consistently and increasing investments as your salary grows. If you let extra income flow into lifestyle upgrades instead, it could derail the plan.
Making the Decision: Invest or Prepay?
From the example, it’s evident that investing surplus funds can generate significantly higher returns than prepaying a home loan. While prepayment offers immediate debt relief and a sense of financial security, investments—especially in mutual funds—can help build long-term wealth through the power of compounding.
The decision, however, depends on your financial goals and risk tolerance. If you prioritize peace of mind and want to eliminate debt quickly, prepayment may be the way to go. But if your focus is on maximizing wealth over time and you’re comfortable with market risks, investing is likely the smarter choice.
How to Use the Investment vs Prepayment Calculator
Using the Credit Dharma’s Investment vs Home Loan Prepayment calculator is simple and user-friendly. Follow these steps to get accurate insights:
- Enter Your Loan Details
Start by inputting your loan amount, current EMI, and total tenure of the loan. For example, if you have a ₹70,00,000 loan with a 20-year tenure, enter these values accordingly.
- Specify Completed Tenure
Indicate how many years of your loan tenure you have already completed. This helps the calculator adjust calculations for remaining interest and principal.
- Adjust EMI Increase
Use the slider to specify how much you can increase your EMI. The calculator will show the new EMI amount and the impact on loan tenure reduction.
- Compare Scenarios
The calculator will provide two scenarios:
Total gains from prepaying your home loan.
Total gains from investing the surplus in mutual funds or SIPs. - Analyze the Results
Review the detailed breakdown of interest savings, investment returns, and tax benefits. The results will help you decide whether prepaying or investing is the better choice for your financial goals.
Confused Between Prepayment and Investment?
Speak to our experts for a personalized strategy. Don’t leave your financial growth to chance!
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!
Frequently Asked Questions
Not necessarily. Consider your risk tolerance and financial stability. Investments carry risk, whereas loan prepayment offers a guaranteed return by saving on interest.
SIPs can offer higher long-term returns with market risk, while prepayment provides guaranteed interest savings and financial peace of mind. The better choice depends on your risk tolerance and financial goals.
If the interest rate on your loan is higher than the expected return on your investments, prepaying your loan may be the better option. This can help you save on interest costs over time. Use a financial calculator or consult with a financial advisor to compare the potential benefits.
Prioritize prepaying high-interest debt like credit card balances or personal loans to reduce your financial burden. It can significantly improve your financial health by lowering interest costs. For a risk-free option, loan prepayment guarantees savings on interest.
SIPs are best suited for long-term wealth accumulation and may not align with short-term needs. As individuals approach their financial goals, they may need to shift to investment options that offer quicker access to funds. This ensures better alignment with their short-term financial requirements.
HDFC Home Loan
SBI Home Loan
