Should you prepay your home loan or invest your extra money? Here's what experts say

Home loans are typically available at the cheapest rates compared to other options like personal loans, loans against property and others. Currently, home loans are available at a rate as low as 7-9 per cent per annum or less but personal loans could be anywhere between 10-20 per cent depending on your credit score, income and occupation. But now the cycle will reverse with high inflation taking the spotlight. This is because the repo rate was recently increased by 0.40 per cent by the Reserve Bank of India (RBI) in the off-cycle monetary policy meet where the clear indication was that rates are expected to go up further with no letting-up in inflation rates.  In such a scenario is it better to prepay your home loan or invest your money?

Long-term loans like home loans allow you to make prepayments. By prepaying a certain percentage of your outstanding every year you can considerably reduce your total outgo. However, while deciding it is also important to note, that there is a deduction against home loan interest repayment of up to Rs 2 lakh under section 24(b) of the Income-tax Act. There is also a deduction of Rs1.5 lakh under section 80C of the Income Tax Act. However, given that, for most people, the deduction limit of 1.5 lakh under section 80C of the Income-tax Act gets exhausted with a mandatory contribution to PF, insurance premium, children's school fees and others, very few people are able to claim a deduction against principal repayment of home loan under 80C. 

There are pros and cons on both sides and having a liability is a big responsibility. The strategy to invest in equities as it has the potential to generate higher returns and continue with the regular EMI can work well until the difference between the investment returns and home loan interest rate is reasonable. 

“Few factors like interest rate, outstanding loan amount, remaining loan tenure and your ability to save every month after taking care of all expenses can help you decide whether you should use the saved money to prepay the home loan or invest the surplus. When home loan interest rates are low investing could be a better option, but you should relook into this strategy when the interest rate increases. Saving on tax is an additional benefit, but you can still work on a plan to reduce the home loan outstanding to the extent that can help you to save tax and at the same time reduce your liability,” says Harshad Chetanwala of MyWeathGrowth.Com, a Mumbai-based financial planning firm.

“Assuming someone is in the 31.2 per cent (including cess) tax slab, on a loan of Rs 25 lakh, if net outgo is Rs 1.2 lakh, it means effective cost of borrowing is less than 5 per cent. And, if the home loan is higher and interest outgo is more than Rs 2 lakh, a borrower cannot claim a deduction against the entire interest paid. There are additional deductions under section 80EEA of the Act, but given the eligibility criteria most people are not able to take advantage of the same,” says Rishad Manekia, founder and MD, Kairos Capital.  

Manekia adds, “Comparing pre-paying a house on loan to an investment in equity is not an apple-to-apple comparison. An investor needs to take into account multiple considerations, starting with the purpose of the investment and how it fits into a person’s financial goals including their overall financial plan whilst also considering the liquidity needs of the investment, the time and cost of maintenance of the asset and finally the returns for the risk taken and how it compares with other asset classes.”

“Most people who opt for a home loan try to repay their loan in 8-10 years. This is a good strategy. This also ensures peace of mind as you become liability-free and you also have your entire monthly income to invest from that stage onwards,” says Chetanwala.

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