Prepay Home Loan or Mutual Fund SIP – Which Option to Use ?

Prepay Home Loan or Mutual Fund SIP – If you are reading this, there’s a good chance you are a Serial Saver – i.e, you are able to save at least 20% of your income every month. If that’s the case, a big Congratulations from Wishfin!

But Saving is just the first step. What you do with your Savings is even more important – do you just leave it in your bank account generating low interest, or do you put it to better use – something that can generate even bigger savings or better returns?

That brings us to the Saver’s Dilemma – What do you use your Saving for?

  • Option 1: Do you prepay part of your Home Loan and bring down your effective interest of your Home Loan?
  • Option 2: Do you invest in Mutual Funds SIP and enjoy the potential for higher returns and build wealth over time?

Well, depends on the following factors –

Reducing Debt Burden:
If you want to maintain a good credit score and don’t want to bear the Home Loan EMI burden for long periods, prepaying your home loan is the best option. If the Home Loan payment period doesn’t bother you then the best option is to invest your salary increment or savings in Mutual Funds SIP.

Emergency Funds:
Wishfin recommends that everyone should provision for an Emergency Fund, just in case of a job transition, children’s education financing, health emergency, etc. Prepay your Home Loan only if you are able to set aside enough for an emergency. If prepaying eats into that, let your Savings go to a SIP.

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Tax Benefits:
Home Loans come with certain Tax Benefits. But so do Tax-Saving Mutual Funds (ELSS). If you prepay your Home Loan, you will not be able to claim a deduction under Section 24(b). Compare what you save under Section 24(b) VS what you can save under Section 80C (Using ELSS Funds), before you take the call.

Bank Charges:
Additional fees may be charged for processing the prepayment. The policies of prepayment are different in different banks, therefore you need to calculate the total amount for prepayment and maturing date payment to figure out whether or not prepayment would be worth the trouble.

Above-mentioned are the most important factors to be considered while deciding whether to prepay the home loan or to invest in SIP. Investing in SIP is the best option as prepaying home loans has more cons than pros, you might have to spend more money in case of prepayment and won’t be able to claim tax deductions; therefore choosing SIP over prepaying home loan seems like the best option.

How Home Loan vs Mutual Fund Calculation Works for New and Existing Customers

Let’s consider someone who is taking a ₹ 30 Lac Home Loan for 20 years at 9% (this would be the most likely scenario) and investment return at 12% (conservative estimate 10 year + returns are 15%-16%).

If he’s a New Customer:
Interestingly, for a new customer a SIP of ₹ 10,000 per month or ₹ 1,20,000/- invested yearly as lump-sum may help to close Home Loan as many as 8 year earlier. If he does an investment of ₹ 25,000 per month. (which is similar to the EMI amount of ₹ 26,000/ month) he may be able to foreclose the Home Loan 13 years earlier! Even if he doesn’t close a Home Loan earlier, he accumulates a large corpus. Winning Option – Mutual Funds SIP (to open up the option of Home Loan prepayment in the future)

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If he’s an Existing Customer:
In case of an existing customer, taking the same example – that he prepays his Home Loan to the tune of ₹ 10,000 /month or 25,000 /month OR 1.2 Lac /year or 3 lac /year, he will only able to completely prepay a year earlier. This happens because the interest payments are amortized in a way that you pay 50% of your principal i.e. about 15 lac in this case, in the last 6 years of the 20 year term. However, if he invests the same, he is able to generate a huge corpus. Winning Option – Mutual Funds SIP

Looks like the cons outweigh the pros for Home Loan Prepayment. And even after factoring in the inherent market risks involved, Mutual Funds SIPs do seem to be better option. But eventually, it’s your unique situation that will tilt the balance in favour of one over the other. Just remember to compare each of the above factors carefully before taking the final call. It’s your hard-saved money after all!