With the country’s economy picking up pace again, the talent retention war between traditional corporate houses and start-ups has led India Inc. back to doling out festive season bonuses.
If you are one of those lucky ones receiving a bonus this festive season, I’m sure you must be puzzled about whether to invest, spend or payback a loan with that amount. Even as apprehensions still loom large over a third wave of pandemic hitting us, there is no guarantee on what the future holds for us.
There’s no right advice on what you should do with this bonus. After all, it’s an individual choice. You can splurge this money on a lavish vacation, which you obviously deserve if you have survived the last 18 months. Or, you can even plough this money into mutual funds or stocks. Growth is what we seek all the time, with our money, career and even life.
Then there is also the option of repaying a certain amount of your home loan outstanding with this bonus. Whether you must partially pay off your loan or not with this bonus may also depend on how low the interest rates are and how close you are to your retirement. Let’s discuss these options in detail.
Low interest rates on home loan: An advantage
This may be your best time to make prepayments on a home loan, as at such low rates, these pre-payments will have a higher impact in reducing your long-term interest. This would, in turn, mean that if you regularly pre-pay while the interest rates are falling, you will be out of the debt sooner.
Before deciding to pay off the loan early, you must consider the interest rate, the remaining balance, and the amount of interest that you will be saving. Meanwhile, it is also to be noted that these are not the only two options to channel your surplus cash.
It is better to use your investment returns to prepay the home loan rather than your annual bonuses or any extra money you have saved up. You can use 10 or 50 percent of your profit, but the basic idea is to use your returns and not the capital.
For example, You have a 50 lakh home loan for a tenure of 20 years at an interest rate of 7.5 percent, and you pay 2 lakh bonus over the years for your pre-payment , then you will be able to pay off your dues in 18.4 years.
Booming markets: An opportunity to invest
In case your mind sways towards the investment angle, keep in mind that you don’t put in a lump sum amount in that. Such an investment must be done through a systematic transfer plan (STP), where the lump sum is put into a liquid fund. It will get invested from the liquid fund to the scheme of your choice.
If you want to prepay your loan, then you need to evaluate the current situation and determine whether it makes sense to prepay the loan. If your home loan interest rate is 7-9 percent and you will be able to draw 10-12 percent from the equities post-tax returns, then it is better to invest in a systematic investment plan (SIP).
For example, let’s say you have a home loan of Rs 30 lakh for 20 years at 9 percent per annum and investment return at 12 percent per annum. If you invest in a SIP of 10,000 per month, you will only be able to pay off the loan a year earlier. This happens because the interest is amortized in a way that you pay 50 percent of your principal, about 15 lakh in the last six years of a 20 year term. However, if he invests the same amount in SIP, then he will be able to generate a huge corpus.
Though stock markets can reward you with sizable returns on investments, there’s also the risk of suffering greater losses. In other words, the market is like a double-edged sword that either giveth or taketh money from you.
Keep in mind the tax benefits while repaying the loan
It is better not to prepay your home loan if you are getting tax benefits out of it and there is time to retire. You can get up to Rs 1.5 lakh benefit on the principal amount and an additional Rs 2 lakh benefit on the interest amount. The extra money in hand will allow you some liquidity. However, if you are nearing your retirement age, it is better to prepay and be free of liabilities.
In short, some of the money could be saved up to use as your emergency fund or to pay off your credit card debts. Some amount can be saved for that post-retirement relaxed life that you’ve always dreamt of. It is crucial to evaluate your situation and then decide what to do with the extra cash. Also, before making any decisions, do evaluate the significant expenses coming in the later months.
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