One of the biggest questions plaguing most home loan borrowers is whether to repay their home loan earlier with surplus funds (read bonuses/windfall gains) or whether to invest the same in investing anew for the future. The entire perspective can be truly subjective in this case but there are a few things that you must keep in mind likewise.
Should you repay your home loan or invest the surplus kitty instead? This is a perennial question as stated earlier. Many people feel that they can opt for investment avenues such as equity mutual funds instead of repaying a big amount on clearing off their home loans. This dilemma is something that is confronted by almost every professional salaried home loan borrower at some point of time. People usually apply for home loans by choosing an EMI amount that they can easily afford and eventually when their income goes up, they discover that they can repay a higher amount than they initially planned for.
What should you do?
Suppose this query was put to a financial expert. He/she would definitely ask the client to first repay the home loan before investing in anything else if he/she is responsible enough. This is because clearing off debt should be the number one priority for anyone. The very first aspect towards planning finances responsibly should be clearing off debt as much as possible prior to saving money.
This is a sound financial plan which should always be adhered to. Of course, when it comes to clearing out credit card dues which attract huge levels of interest, these should be prioritized above savings. Most big loans like car loans and home loans do not attract as high a rate of interest as unsecured loans such as personal loans or credit card debt. Some experts feel that long-term investments made in channels like equity mutual funds or other instruments may possibly garner higher rates of returns as compared to the interest that is being repaid on the home loan. SIPs have given higher returns for 10-15 year periods previously in many cases as well. So an option could be to accumulate savings for the long haul while repaying the home loan without clearing out so much money on the same.
Additionally, another factor to be kept in mind is the tax benefits that are available on a home loan. You can get up to Rs. 1.5 lakh under Section 80C on the principal repayment although this section covers other payments such as insurance, PPF and the like. Under Section 24, you can get tax breaks up to Rs. 2 lakh on the interest that is repaid. If you and your spouse are co-owners of the property then both of you can claim deductions separately. As a result, maintaining the home loan will enable you both to claim your tax deductions. Clearing off the home loan will naturally limit the tax breaks that you are getting now. Taking a home loan means that you can now have your own property without having to pay any rent. As a result, once you have built up a sizable corpus throughout the early years of the loan, it could be wise to repay off the remaining amount later on.
However, the early years is when the most interest is charged. As a result, repaying the home loan in stages in the first few years will naturally cut down the overall interest greatly and reduce your EMIs. Keep your EMIs intact without reducing them and the extra principal amount reduced will be substantial indeed. Human psychology is another aspect worth pondering over. If someone does not have any savings or very little savings in his/her account, he/she would naturally want to keep the loan going but build some savings at the same time. This is a natural philosophy since having access to surplus funds is necessary not just to have some financial security for the family but also to repay the loan when needed or in case of exigencies. This is something that cannot be denied by all means. Another factor is that you can always clear off debt; clearing debt early on is the good thing to do, particularly when you are in your early years.
Thus what do you do when so many factors come into play? Here are some of the key things you might try for balancing everything out:
- First create an emergency fund which should ideally have 3-6 months of your current salary. This should be saved up irrespective of your loans and other investments. This is the first step in the entire financial planning process.
- Next, build up a corpus of 2-3 months of your salary while repaying the home loan diligently as your usable savings.
- While you’re at it, you can consider allocating your surplus funds in a 60:40 or 50:50 ratio, depending on what your needs are, to loan prepayment and investments for the future. This will keep both your goals intact.
- Once your EMI reduces after you prepay the loan, do not change the EMI amount and bring it lower. Keep the same amount you paid before since this will also help in slashing the loan down even further.
- Increases in income should also be allocated accordingly- building up your savings account, repaying the home loan and investments for meeting future goals.
Following a balanced approach could be the best way to strike the right balance in this regard.