Healthy financial conditions will open multiple options for you to utilize your money and take decisions accordingly. Based on your options, choices, and finances your life goals will be impacted. So, it is always advisable to consider various parameters while making any decision.
Similarly, when a question comes on decisions of spending or saving, a question that many people would like to ask is “Should I prepay my home loan or invest for retirement?”
Trying to decide between eliminating debt (Home Loan) and investing in the future is a difficult decision.
No doubt clearing a home loan with prepayments will reduce your burden but on the other hand, saving for investment also lets you enjoy life without any worry. So, both the options for your benefit but the matter are what to choose?
Let me help you to give a glance at the benefits available under both options.
Prepayment of the loan will not only help to reduce your burden but also gives you the benefit of saving tax.
As per current income tax laws, you can avail of the deductions for the payment of principal amount under Section 80C up to the amount of Rs. 1.5 lakh and the interest portion of the EMI paid for the year can be claimed as a deduction up to a maximum of Rs 2 lakh under Section 24.
So, if your annual interest outgo is higher than Rs 2 lakh, it makes sense to prepay the loan and save on future interest payments.
Alternatively, Investment instead of prepayment of home loan should have opted only when the after-tax return from the investment is likely to be higher than the effective cost of the housing loan. Although, there are several risk-free, tax-free debt options such as PPF, SIPs, Mutual Funds, Sukanya Samruddhi Yojana and listed tax-free bonds, which offer higher annualized return than the cost of EMIs.
Moreover, in case you are looking for long term benefits and also a risk-taker, you can also consider investing in equities, which will provide you higher returns in comparison with the expense of EMIs. Usually, investment in equity funds provides you with returns ranging from 8 percent to 15 percent (Higher than other investing options).
So, generally, we can sort out such a decision by comparing the opportunity costs. In simple words, opportunity costs compare the return you will get when you invest the lump sum amount and the EMI into another product versus invest in your property investment after bearing the costs of interest and maintenance and adding rent (like income if you get any).
Now, How to calculate the benefits of prepaying a home loan?
Here are the few steps you need to follow to find out the opportunity cost to take a rational decision:
- Plan your calculation sheet by asking for the prepayment EMIs schedule options from your bank and look for the other investment options return available.
- Now, compare the expenses of housing loans along with the returns of investing options (or you might simply compare the rate of returns in both cases).
- Lastly, consider all the tax benefits you can avail as well as the tax you have to pay on your invested returns (generally in case of equity) or can opt for the tax-free investment options.
- If you have the opportunity to earn a higher return than the interest on the home loan, prepayment would be beneficial in financial terms.
However, one should not only stick on the number of calculations to take the decision but also consider other factors as well
- You have to think mentally which alternative will give you more leverage like will being debt-free make you happy or enjoying returns on investments.
- If you thinking to get higher returns in equity, will you be able to take the risk and have other options of earning to cover up in case of loss as the market remains volatile and emotions never play any role.
- Consider your liquidity position as well as if you need to have liquidity for short term, equity investment might not be a good option.