Paying off home loan or making an investment: Which is a better option

Younger people may invest for they have a longer time horizon, while those nearing retirement might focus on debt reduction

In the heart of Gurgaon's gleaming Cyber City, Arun Singh stares at his computer screen, his finger hovering over the 'submit' button. His company has given him a bonus and he faces a dilemma: Should he use the money to prepay his home loan or make investments?

 

The decision to prepay a home loan or invest in financial instruments is a dilemma faced by many homeowners. Making a choice depends on various factors, including interest rates, potential returns from investments, tax benefits and financial goals.

 

Key points to consider: prepaying home loan vs investing

 

Interest rate comparison:

 

Compare your home loan interest rate with potential investment returns.

 

Tax implications:

 

Compare tax deductions available on home loan interest versus tax implications on returns

 

Risk tolerance:

 

Prepaying a loan offers guaranteed returns in the form of interest savings.

 

Investments, especially in equity, carry market risks but have the potential for higher returns.

 

Financial goals:

 

Align your decision with short- and long-term financial objectives.

 

Consider if becoming debt-free earlier or building a larger investment corpus is more important to you.

 

Job security and income stability:

 

In uncertain economic times, reducing debt might provide more peace of mind.

 

Stable income might allow for more risk-taking in investments.

 

Age and life stage:

 

Younger individuals might benefit more from long-term investments.

 

Those nearing retirement might prefer the security of a reduced or cleared home loan.

 

Emotional factors:

 

Some people sleep better knowing they're reducing their debt burden.

 

Others might feel more financially empowered by growing their investment portfolio.

 

Loan tenure remaining:

 

Prepayment in the early years of a loan saves more interest than in later years.

 

Consider the impact on your loan tenure if you make partial prepayments.

 

Emergency fund:

 

Ensure you have adequate emergency savings before considering prepayment or investments.

 

Future credit needs:

 

Maintaining a loan account in good standing can be beneficial for future credit requirements.

 

Fully closing a loan might impact your credit mix and score.

 

“Whether you should repay your home loan or invest would depend on a few factors. The biggest of them is the return that you expect to earn on your investments (and thereby the choice of the investment instruments) vs. the rate of interest charged on your home loan," said Gaurav Arora, fund manager at Equirus.

 

"If you are a prime customer whose home loan interest rate is between 8 to 10 per cent, it makes financial sense to invest that money in equities and related instruments for the long term. Since home loan is a long-duration product, it would fit in with the long-term nature of investment required for equities.”

 

“The benefit of tax savings on repayment and the proposition becomes even better. However, if the home loan interest rate is in the teens, as charged to less-than-prime customers, it is probably better to repay the high-cost home loan first. Another nuanced point which many fail to appreciate is that plenty of people who make money through real estate do so because of the high but relatively safe leverage inherent in real estate purchases. Prepayment of loan would defeat that whole premise,” he said.

 

“Over a typical 20-year home loan tenure, even investing in index funds instead of prepaying could yield a significantly higher corpus due to compounding and the differential between index fund returns and net borrowing costs. However, if your future cash flows are uncertain or constrained, early repayment might be prudent," said Priyank Shah, co-founder and chief executive officer of The Financialist, a financial advisory company.