Should you repay your home loans now or go for investments?
The final decision will depend not only on the return numbers, but also the qualitative factors such as your mental setup, your financial needs and your current financial health.
The economy is made up of several moving parts which impact each other in different ways. Intersperse this with your personal requirements, and it makes for multiple choices in decision making. Based on the choices you make, your finances and in turn your life goals will be impacted. So it is wise to make a decision looking at all relevant parameters.
In the current scenario one question that many people would be grappling with would be the choice between investing into the equity market, buying a home or repaying home loans. As of now we are seeing a decrease in home loan rates and an upward trending equity market. If you have money in hand, what should you do, prepay a part of your outstanding loan or invest into equity or property?
If you want to buy a new house for personal use, then it is more of an emotional decision, so you might as well go ahead in buy it, even if renting makes more sense than buying-mathematically speaking! When it comes to putting in money into a house as an investment, there are many factors you need to look into, including the opportunity cost. Buying a house means putting a lumpsum as down payment as well as a regular payout in EMI. The opportunity cost lies in whether you will get a better return if you invest the lumpsum and the EMI into another product versus return on your property investment after bearing the costs of interest and maintenance and adding rent if you get any. Besides, there is also the convenience factor to consider.
Let us look at a scenario where you have an ongoing home loan and have some lumpsum money available. In such circumstances, should you choose to part-prepay your loan or invest the amount? Assuming the original loan was Rs.60 Lakh taken in Jan-2013 at the rate of 9.5 percent for 20 years and EMI of Rs.55,928 per month.
Look at the table below, which shows the total interest you will pay and the date of completion of the loan in different scenarios. It is assumed that you will move your loan to the current interest rate of 8.6 percent. That itself will move the completion date of your loan down from Jan-2033 to May-2031. If you part prepay an amount of Rs.11,00,000 your loan will get over by Nov-2026.
Please note that the return figures are assumed and the calculations are not exact and are meant for ease of understanding the scenarios.
If you choose to invest the amount instead of pre-paying the loan, you could get a range of returns. I have analysed scenarios ranging from 8 percent to 15 percent return, assuming an investment in equity funds. I have also assumed that you will close the loan once the investment amount is equal to the outstanding loan. You can see that even at a pessimistic return of 8 percent you will be able to close the loan more or less at the same time as you will if you make the part pre-payment now. The difference being in the total amount of interest you will pay in both these scenarios.
The final decision will depend not only on the numbers as shown above, but also the following factors:
1. Your mental set-up. Will being debt free make you happy? Or you enjoy getting returns on leveraged investments? Your mental set-up will be the first point of decision.
2. What is your risk profile? Will you be able to live with the volatility of equity as an asset class, if the money is to be invested in equity? Your investment might fluctuate over time and might even show negative returns in some periods.
3. Job security: Will you be able to manage the EMI’s if there is a job loss? Is there an alternate income available (spouse’s income/rental etc) or are there sufficient funds for emergency that can help tide over the phase till you get your next job?
4. How prepared are you for your other financial goals? If you have a child’s higher education coming up in a few years, you might want to keep the funds invested in appropriate instruments rather than repaying the home loan.
5. What is your liquidity position? If you are asset rich but cash poor, you may want to consider improving your liquidity by investing the amount in debt instruments rather than repaying the loan.
After considering all the above factors, if you decide to just opt for the lower interest rate on the home loan, without making any part prepayment and invest the amount of Rs.11 lakh into equity funds, you stand a chance to make a corpus of about Rs.50 lakh to Rs.80 lakh (assuming a return range between 12 percent-15 percent) by the time your loan gets over in May-2031. This can be utilised for goals like education for children or your retirement.
If you realise that you need to have liquidity for short term, equity investment might not be a right choice for you. In such a case you may want to look at moving your home loan into a super-saver or smart home loan kind of structure where the spare funds can be held in the home loan account. This will reduce the interest on the home loan while providing you with liquidity at the same time, with a rate of return equivalent to the rate of the home loan. If you have a major goal coming up in less than five years, you may want to look at debt mutual funds for investing your money.
So you can see that it is not an answer that can be the same for everyone, it entirely depends on individual circumstances and should be dealt with accordingly.
Kiran is a member of The Financial Planners’ Guild , India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.