Pavitra received Rs. 3.5 Lakhs from the sale of a family property in her native place. She has a housing loan of Rs. 30 Lakhs for which she is paying a monthly EMI of Rs. 35,000. She has completed 2 years of the 7 years of the loan tenure. Pavitra is thinking about repaying a part of the loan with the entire inheritance amount while her husband is of the opinion that they must invest a part of it for their children’s education in mutual funds or equity shares.
Often, these complex decisions spring in front of us when confronted with a lump sum gain on one hand and a mortgage on the other. In case of a car loan or a personal loan, the choice is very clear – one must repay the loan as soon as possible as the interest is very high and the value of a loan investment only depreciates. Besides, these loans do not have a long tenure as housing loans have.
Home Loan Outlook
In Pavitra’s case, at a monthly interest of 10.5%, she ends up paying around Rs.3,15,000 annually only on the interest amount which works out to Rs. 47,25,000 in 15 years, raising the cost of the house by over 50%. If she uses her inheritance money to repay the loan, the number of instalments she has to pay will be reduced which implies that the total amount to be repaid will be reduced since the duration of the loan will come down from the remaining 5 years to just under 4 years.
Comparative Analysis of Actual Savings and Growth of Corpus
How much benefit you accrue from investing on an alternate source depends on the type of investment you are making. In Pavitra’s case, if instead of repaying the home loan, she would have invested the amount in purchasing a Blue Chip Fund or a child plan for her daughter’s education, the returns cannot be forecasted. However, if the blue chip fund returns after 3 years’ investment were to give her a return of Rs. 8 Lakhs then she would be able to pay off a bigger chunk of her debt and saved 2 years’ instalments instead of 1 year.
Another scenario is where a person might also have a personal or a car loan. In such a case, it is best to pre-pay that loan first as the interest rate is higher in the shorter term.
A Case for Prepayment
The greatest advantage of pre-payment of a loan is that it significantly reduces the interest cost which will bring down the purchase price of the house by a large amount. So, even if you are considering reselling the property to purchase a bigger property in the future, you will be able to recover the cost faster and make better profits. However, you must understand that you have already paid the loan processing charges for the entire tenure; so, if you are earning better returns elsewhere, then you can consider it so that you can utilise the returns to pay off a bigger portion of the loan.
Tax Rebate
Home loans attract a tax rebate under the Income Tax Act, so often individuals prefer to continue their loan for the entire duration. However, if you are paying an EMI of Rs. 35,000 and your tax saving is Rs. 1000; it does not appear to be a very big saving. Besides, there are other tax saving avenues which are more beneficial. You could even invest in another property as real estate delivers the highest returns among all investment classes.
What are the Investment Avenues in Such Cases?
If you do not want to prepay your loan with the extra amount you have, then there are the following investment options:
- Equity: If you have a high risk appetite, then investing in equity can generate more returns than you would have saved from pre-paying the home loan.
- Real Estate: You can invest in another property. It would mean an additional loan, but if you can earn a rental income, then the loan will get repaid partly by the rental returns. Besides, you can sell one property to leverage the loan repayment for the other property.
- Provident Fund: PPF gives you a tax benefit for the entire Rs. 1 Lakh you deposit in the account and attracts an interest of around 8%. You must ensure that you complete the entire deposit amount for the year before paying off the debt. This will also set up a savings corpus for the future.
You have to pay the EMI on your housing loan till it is completely repaid. The EMI and the interest rate amount also remain constant. On the other hand, the return on investment from equities fluctuates and from secured bank deposits, the interest rate is not as high as it is on the loan. If you are nearing retirement, it is most likely you are close to the final installment of your home loan. If you repay your home loan earlier, you can concentrate on savings and investment for your post-retirement years.
For those who are younger and still have a few years, do not compromise on your other financial responsibilities such as insurance premiums, child plans, savings corpus to pay off the home loan.