In the world of personal finance, many face the daunting challenge of balancing debt repayment with wealth creation.
Let’s take the example of Ms A, who has a Rs 1 crore home loan with a monthly EMI of Rs 86,000, stretching over 20 years. Now, suppose she gets a pay hike of Rs 24,000 per month, which opens up the possibility of accelerating the loan repayment or venturing into investments. This decision demands careful long-term consideration of her financial future.
This is not just about numbers; it’s about aligning financial strategies with life goals, risk tolerance, and future aspirations. Both options—early loan repayment and strategic investments—have their merits and pitfalls, making this choice one of the most critical in crafting a secure financial future.
Also read: Bull-run dilemma: Should you prepay home loan or keep investing in equities?
Option 1: early loan repayment
Increasing the EMI from Rs 86,000 to Rs 1.1 lakh can cut the loan tenure significantly, reducing it from 20 to 13.75 years. This strategy saves Rs 35 lakh in interest costs over the course of the loan.
Pros:
- Immediate reduction in financial stress associated with long-term debt.
- Guaranteed savings in interest expenses.
- Early freedom from a significant financial obligation.
Cons:
- Funds locked in a home loan lack liquidity.
- Missed opportunities for potential higher returns from investments
- Limits flexibility for future financial emergencies or goals
Option 2: Invest the surplus in SIPs
Alternatively, one could maintain the existing EMI and invest the surplus Rs 24,000 in systematic investment plans (SIPs) with a potential annual return of 12 percent. Over 17 years, this approach could build a corpus of Rs 1.6 crore.
Pros:
- Liquidity for emergencies or other financial needs.
- Compounding generates significantly higher returns than the interest saved by prepayment.
- Diversifies wealth into equity markets, offering a hedge against inflation.
Cons:
- Returns depend on market performance, introducing an element of risk.
- Requires patience and discipline to stick to one's investment plan through market fluctuations.
Hence, one should weigh both options carefully.
Also read: You're doing SIPs, but are you doing it smartly?
While early loan repayment provides psychological relief and guaranteed savings, investing in SIPs has the potential to create substantially greater wealth over the long term. This apart you need, factor in several other parameters too.
1. Tax benefits: you can deduct up to Rs 1.5 lakh from your income against the home loan principal repaid, and Rs 2 lakh on the interest. This reduces the effective cost of the loan, making investments more appealing.
2. Liquidity: SIPs provide flexibility and easy access to funds, whereas prepayments lock the money in an illiquid asset.
3. Risk vs reward: SIPs, with expected returns of 10-12 percent, can outperform the 8.5 percent home loan interest rate, but they come with market risks.
4. Time value of money: early investments benefit from compounding, leading to exponential growth over time.
5. Inflation hedge: SIPs protect purchasing power better than fixed loan repayment schedules.
6. Diversification: SIPs can reduce concentration risk by spreading wealth across asset classes.
7. Opportunity cost: Prepaying a loan may mean forgoing potentially higher returns from investments.
8. Financial freedom: SIPs can generate passive income, creating opportunities for financial independence sooner.
9. Psychological comfort: loan prepayment offers peace of mind by reducing debt, while SIPs demand tolerance of short-term volatility.
10. Economic trends: rising interest rates may favour prepayments, while stable or declining rates encourage investments.
A balanced approach
Ultimately, balancing debt repayment with wealth creation is key. For someone in this position, a combination strategy might work best:
- Continue regular EMIs to manage the debt systematically.
- Invest the surplus in SIPs to build wealth and maintain liquidity.
With this, one can steadily reduce the loan burden while taking advantage of equity markets’ long-term growth potential.
The key takeaway
Debt need not be an adversary—it can be a tool. Strategically balancing debt repayment and wealth creation offers the best path to financial independence. By considering liquidity, returns, and risk tolerance, you can chart a course that ensures both peace of mind and long-term prosperity. Use the power of discipline and compounding to turn financial challenges into opportunities for growth.
Disclaimer: The views expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.
The author is Founder, True North Finance, a Financial and Investment Planning Firm based in Pune.
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