Home loan vs mutual fund investment: When purchasing a home with a home loan, it is important to assess our current financial situation to determine the affordable Equated Monthly Installment (EMI). As our income grows, we may encounter the dilemma of whether to make prepayments towards our home loan or invest in a mutual fund. With loan rates exceeding 9 percent for many individuals, borrowers may be experiencing the impact of higher interest costs. In light of the fact that rates are now surpassing the yields of many safe debt instruments, it may be advisable to consider making prepayments if financially feasible.
At times, when we receive a lump sum of money, we contemplate whether investing in mutual funds would yield better returns than paying off our home loan early. So how to decide what’s right?
Factors that should be considered when making this decision include financial objectives, risk tolerance, expected rate of return, and prevailing interest rates. Ultimately, the decision to invest in mutual funds or prepay a home loan hinges on individual circumstances.
“When contemplating the prepayment of a home loan, it’s important to consider the opportunity cost of capital that may offer higher long-term returns and capital appreciation and also, your cashflow position i.e. whether you can continue to repay the EMIs with ease through the tenure of the loan. One should also consider the potential changes in interest rates. If interest rates are expected to decline, it’s not advisable to prepay; instead, take advantage of the low borrowing costs. Conversely, if interest rates are on the rise, it may be a good time to at least consider partly repaying the loan,” said Priyank Shah, Co-Founder & CEO of The Financialist, a startup.
Though tax benefits associated with home loans can lower post-tax rates, for many individuals, it is still preferable to pay off their loans as soon as possible.
“Tax implications play a crucial role in investment decisions, particularly regarding home loans. Under Section 80C, principal repayments are eligible for a deduction up to ₹1.50 lakhs. Interest payments can be deducted under Section 24(b), with varying rules for self-occupied versus let-out properties. However, in the new tax regime, these deductions are not available for self-occupied properties, and for let-out properties, deductions are limited to the taxable rent, with no option to carry forward losses under “Income from House Property,” said Shah.
Before making the decision to repay your home loan, it is essential to consider your future financial needs. Home loans typically offer lower interest rates compared to other loan options, such as personal loans. If you repay your home loan and find yourself in need of additional funds in the future, you may end up borrowing at a higher rate of interest. Therefore, carefully evaluate your future requirements for funds, including known expenses and potential emergencies, before deciding to pay off your home loan.
“When we pre-pay the home loan, we not only miss out on the opportunity cost of capital but also the tax benefits that come along with the home loan. When we have bought a house on loan and invest the corpus in the equity markets for a period equivalent to the tenure of the home loan, we not only create a tangible asset in the form of a house but also enable compounding on our equity portfolio,” Shah added.