Pavitra received Rs 3.5 lakh from the sale of family property in her native place. She has a housing loan of Rs 30 lakh for which she is paying an EMI of Rs 35,000. She has completed two years of the 7-year loan repayment tenure. She is thinking of prepaying a part of the loan with the inheritance, 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, such 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: You must prepay such high-cost loan as soon as possible. Besides, these loans do not have a long tenure as housing loans.
Home Loan Outlook
In Pavitra’s case, at a monthly interest of 10.5 per cent, 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 per cent.
If she uses her inheritance money to prepay the loan, the number of instalments she has to pay will be reduced, which implies that the total amount to be repaid will also be lower since the duration of the loan will come down from the remaining five years to just under four years.
Comparative Analysis
How much benefit you accrue from investing on an alternative source depends on the type of investment that you are making.
In the current case, if Pavitra does not want to prepay the home loan, she has to invest her inheritance in a blue chip fund or a child plan for her daughter’s education. The returns, however, cannot be forecast.
If the blue chip fund gives her a return of Rs 8 lakh after three years, she could pay off a bigger chunk of her debt and save two years’ instalments instead of one year.
Another scenario is where a person might also have a personal or a car loan. In such a case, it is best to prepay 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 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, you must consider such option as higher returns would help in paying off a bigger portion of the loan.
Tax Rebate Home loans attract a rebate under the Income-Tax Act. 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 1,000, 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.
You have to pay the EMI on your housing loan till it is 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 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 instalments 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 low-cost home loan.