What would you do if you have taken a home loan and happen to receive some surplus money via maturity of your old investments, bonus or in any other form. It has been observed that people, especially salaried class, are always willing to close their loans as it reduces their burden. But having received some surplus, should you choose to pay off your loans or invest the money in some better asset class to generate great returns? Let’s understand the different scenarios:
When you should not pay off your loans?
Mental stress: Unless you really carry a stress of having a loan on your head and it is really bothering you big time you should not jump to pay off your loans without analysing the pros and cons of it. You should also think about the intensity of stress, whether it is more out of your fear which doesn’t exist or really out of a well-thought plan.
Loss of tax benefits: Home loan offers you two tax advantages, one is on account of interest you pay on your home loan and the other on the principal. Where the interest benefit is given up to an extent up to Rs 2 lakh under section 24(ib) and principal benefit is given under section 80C for a limit up to Rs 1.5 lakh. If you have a joint ownership with your spouse or a relative, then the interest limit will be Rs 2 lakh individually and also your 80C investments are not exhausted then there is a great benefit as well. Put together, you would be able to save around Rs 1.08 lakh in taxes i.e. 30.9% on total Rs 3.5 lakh (interest +principal) so evaluate your tax benefits before paying off your loan.
Opportunity cost: If the surplus money you have cannot be utilised elsewhere, or say put to better use, both personally or by investing in an asset which offers you more returns than the interest what you are paying.
Liquidity crunch: Once the loan is prepaid, you will lose the surplus money and may face a liquidity problem.
How a monthly SIP equivalent to 10% of your EMIs can make you recover entire EMIs?
One interesting way to recover you’re the entire EMIs can be by investing say only 10% of your EMIs in a mutual funds SIP which has a potential to earn way better than your home loan interest. The accompanying table shows the net surplus you may earn by investing just about 1/10th amount of your EMIs simultaneously in a mutual fund having a higher rate of return. So by investing just 10% of your EMIs and assuming that you will be increasing the SIP amount by 8% annually, you would be able to recover your entire home loan payment.
The final decision would also be based on the following three factors:
1. Your thought process: Will becoming debt-free totally make you feel very relaxed or you prefer to earn handsome returns on opportune investments? Look at the stage you are in to with respect to your financial cycle of life and decide accordingly.
2. Check your risk appetite: Will you be comfortable to live with the unpredictability of equity i.e. mutual funds as an investment asset class thought it has a huge history of potential to generate great returns.
3. Job security: Have you saved enough to manage the EMIs in case of a job loss or is there backup available?
Conclusion: So, don’t rush to pay off your home loans just because you consider it to be a burden or have attached a bad image to the term loan. Think that the house you have built or purchased would not have been there if the home loan in question wasn’t easily available. I strongly suggest that you make sure you create good wealth to pay off the loans always, but never without doing a proper financial planning.
The writer is a chartered accountant and chief gardener, Money Plant Consultancy