At a time when equity markets perform well, interest rates are at a low level and you have surplus funds, you might wonder whether to opt for home loan prepayment or investment. As per industry estimates, the average housing loan tenure is 8 years, which means most often prepay the home loan. This is not surprising. When buying a home, the EMI forms a considerable portion of your payment. While you may use a housing loan EMI calculator to set a suitable EMI as per your repayment capacity and home loan eligibility, many may extend the tenure to lower the home loan EMI.
But, after a few years, post job changes and salary increments, the EMI as a percentage of whole income lowers. Most of you at this point begin to prepay your home loan with surplus funds. You may also use a home loan EMI calculator to calculate your overall savings on interest component post prepayment. However, to determine whether to prepay your housing loan, you must evaluate your present condition.
Prepay or invest – What should be your decision?
If you look at the figures, there is a thumb rule that states – if you generate a better after-tax return than current home loan interest rates, you must not prepay. Instead, you must invest the funds. For instance, home loans from lenders at present may offer around 7 percent p.a. rate. And most may avail around 9 to 10 percent of after-tax returns on equities over a long run. Going by the rule of thumb, beginning an SIP (systematic monthly plan) for a long run comes across as a better option because the return on investment is around 2% higher than the rate on a home loan. However, as the equity market is volatile in nature, there may be a chance that despite stretched equity valuation, the returns may become subdued. In such a scenario, you might think that prepaying was a better option than investing in equities. Thus, you must not always go by the rule of thumb.
Before you decide to make home loan prepayment, make sure your basics are fully covered. You must have a contingency fund of at least 6 months of your monthly mandatory expenses in place. Also, you must have adequate health and life insurance as they prevent you and your family from defaulting on your home loan EMIs in case of misfortunate events. You must also ensure to check if you are saving sufficient to attain your financial goals. In case you are lagging, it is better you step up your monthly investments initially before prepayment.
A prudent step is to use the profits from investments to make home loan prepayment, instead of using your bonus or additional saved money out of your salary. You must use a portion of your investment profits to prepay your home loan in place of using up the capital. Whether you use 5%, 10% or 60% of the investment profit is completely up to you. The basic idea here is not to consume your capital.
Few experts believe that you must not prepay if the home loan tax benefits available to you are considerable, and there is time to retire. For instance, if you avail a tax benefit of up to Rs 1.50 lakh on principal component and up to Rs 2 lakh on interest component on home loan, then it is better to stick with home loan than go for prepayment. The additional money in hand per year will endow you with liquidity. In such a condition, prepayment makes sense just when you are near to retirement and want to end all your liabilities. However, before you decide, check if you have any major expenses a few months later. If you have any major expenses coming up, avoid prepaying your housing loan. This is because after a few months, to meet the additional monetary mismatch you may either be propelled to take a loan or redeem your crucial investments earmarked for important financial goals, which may indirectly hamper your financial health.
Ending note
A home loan is an excellent financial instrument to save taxes on both fronts – principal and interest repayments. So, continuing with your home loan might help you save considerable tax if you fall in the higher income slab. However, in case you are not able to attain considerable tax benefits, it makes complete sense to make prepayments to bring your outstanding debt down to a level where you may optimize your home loan tax benefits.