Should you invest your bonus or prepay a loan? Use a lumpsum calculator to decide

Every now and then, we may find ourselves with a lumpsum amount—through a bonus, an asset sale, or a matured bank deposit. For those who have financial commitments like EMIs, a question that may then arise is – should I use the amount to prepay the loan, or is it better to invest that amount?

The answer isn’t universal. It depends on a few key factors—your loan’s interest rate, your risk appetite, how long you can stay invested, and your current financial comfort. This article tells you more about these factors to help you navigate this decision. 

Loan EMIs are a monthly fixture. If there’s a chance to reduce or close that obligation earlier, it can feel like a relief. Prepaying a loan also cuts down the total interest you end up paying. This can be especially useful when the loan has a relatively high interest rate.

For longer-tenure loans, such as home loans, even a small prepayment in the early years can reduce the interest burden. Another point in favour of prepayment is predictability. There’s no market risk involved. You know how much interest you’re saving. For someone who prefers certainty, this route might feel more straightforward.

If you’ve got a lumpsum amount and your loan EMI feels manageable, you might consider investing that money instead. 

This is where a lumpsum calculator can come in handy. Plug in how much you plan to invest, how long you’re willing to stay invested, and a rough estimate of expected returns. Bear in mind, though, that the calculator’s estimates are based on your expected rate of return. Actual returns depend upon market conditions are not fixed or guaranteed. Still, the tool can give you an idea of how much your money may potentially grow with time – and if that growth could potentially surpass your loan interest burden.

Some mutual funds—especially those with equity exposure—have the potential to deliver returns that outpace the loan interest rate in long term. Say your loan interest is 8%, and the fund you choose averages 12% returns a year over the long run, you might end up ahead. But these are just possibilities, not promises. The markets have their ups and downs, and that’s something to be mindful of.

Your comfort with this kind of uncertainty plays a crucial role. If you can withstand some market volatility and short-term dips and plan to leave money untouched for a few years, this path may work for you. On the other hand, if you prefer clarity and dislike market swings, you may find prepayment better.

Start by looking at the numbers. If your loan interest rate is higher than what you realistically expect from investments, prepayment may be more suitable. If the reverse is true, investing could potentially offer value.

But numbers alone don’t decide everything. Your financial situation matters. Do you have an emergency fund? Are you managing your EMIs without any strain? If yes, you might be in better place to take on the uncertainty that comes with investing.

Another point to consider is liquidity. Once you use the lumpsum to repay your loan, it’s locked in. You can’t easily get that money back. With mutual fund investments, especially open-ended ones, you usually have quicker access to your funds if something urgent comes up.

There’s also the tax angle. Some loans—like home loans—offer tax deductions on interest paid. If you prepay, you could lose out on that benefit. So, factor in the net savings after accounting for the tax effect.

For many investors, a middle ground may be more suitable. You can choose to part-prepay the loan and invest the rest. This way, you reduce some debt while still giving part of your money the chance to grow.

It doesn’t have to be an exact 50-50 split. You could decide based on which option gives you more peace of mind or based on how long you plan to stay invested.

Once again, a lumpsum calculator can help you run a few scenarios. Try out different combinations—prepaying a portion versus investing entire amount. This may give you some more clarity.

No matter what you choose to do with your lumpsum, it’s still important to invest regularly. A Systematic Investment Plan (SIP) can complement your approach. Even if you prepay your loan, you can simultaneously work towards your financial future by investing in mutual funds through SIPs. 

SIPs can be convenient because they don’t require large sums. Over time, this consistency can potentially result in wealth accumulation over long term, without the pressure of timing the market.