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Sunday, 23 August 2020

Home Loan: To Pay off early or to invest ?

I had watched lot of finance related educational videos when I was planning for home loan. I still watch sometimes to understand the things I may not be totally sure about. It’s informative for sure but let me tell you, it is not as tough and complicated as it seems like or the way it is presented. Investment and loans and when to pay/repay and how to pay can never have one generic answer that applies to everyone and in every case. Now before I start to explain further this deviation from general consensus regarding loans, it applies only to Home loan as Home loan interest rate is much lower compare to any other loan, though in some cases it may apply to other loans too if interest rate is relatively lower.

Home loans :

Every video you see over this topic says pay off your home loan as soon as possible as the interest you pay on it is too high in longer run. Agree, but under what circumstances it is high and low ? what decides that ? It is the interest rate and nothing else.

Case 1 : Say the home loan you have taken is for 15 years with floating interest rate of 14-15% (average of most of the banks). If your EMI is 30K and you can save some 15K from your salary as saving apart from all your needs and wants expenses, then definitely you should try to pay extra in EMI as those 15K rather than investing it somewhere.

For example in August Month you have got extra 15K Rs and you pay it with EMI of home loan. On this 15K in next 15 years you will save interest of around 25000 from your home loan. Now suppose rather than paying 15K in home loan EMI, you want to invest it in a safe option. You have got FD with interest rate of 8 odd percent or PF with interest rate of 8%. The money you will make with investing 15K in PF in 15 years will be same or little more as compare to extra saving on your home loan interest. I am discarding mutual fund investment here as I am just trying to compare fixed loan rate pay with guaranteed return on investments only.

Case 2 : Say the home loan you have taken is for 15 years with current floating interest rate of 6.5-6.75% (average of most of the banks). If your EMI is 26K and you can save some 15K from your salary as saving apart from all your need and wants expenses, then you should try to invest this 15K somewhere rather than adding in home loan EMI.

For example, in August Month you have got extra 15K and you pay it with EMI of home loan, on this 15000 in next 15 years you will save interest of around 8500 from your home loan. Now suppose rather than paying 15K in home loan EMI, you want to invest it in a safe option. There is FD with interest rate of 6 odd percent or PF with interest rate of 8%. The extra money you will make with this 15K in PF in 15 years will be around 30K which is much higher than saving of around 8500 in home loan interest.

So, it is just the game of loan interest rate and availability of better and safe investing option. If home loan interest rate is lower than a safe and guaranteed higher rate investment option, don’t pay extra in EMI, rather invest in that safe and higher rate investment option. Another advantage of not paying off extra in loan EMI in case 2 is exemption in tax on home loan interest. If Home loan interest rate is much higher than a safe and guaranteed rate investment option, pay extra in EMI, rather than investing.