Prepay a home loan or invest in equity? Here’s help in deciding what to do with your festive bonus

prepay home loan or invest


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Last updated on 19th October 2023

Every festive season brings with it a wave of joy, celebrations, and for many professionals, a much-awaited festive bonus. This unexpected financial gain often presents a dilemma: should i prepay home loan or invest it elsewhere? For homeowners and investors alike, this decision can have long-term implications. Here, we break down the factors that can help guide this choice, highlighting the benefits and considerations of both options.
The decision largely rests on two factors: the current interest rate on your home loan and the expected returns from equity investments. While prepaying a home loan might offer immediate relief from monthly commitments, investing in equities could potentially provide higher returns in the long run. It's essential to weigh these options against your personal financial goals and risk appetite.

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What Attracts Homeowners to Prepay Their Loans

Understanding Home Loan Prepayment

 Home loan prepayment refers to the act of paying an extra amount towards your home loan principal, over and above your regular EMIs. This not only reduces the principal amount but also results in a significant reduction in the total interest paid over the loan tenure. This method not only accelerates the process of becoming debt-free but also results in substantial monetary savings in the long run. Therefore, for individuals with some extra funds on hand, opting to prepay home loan can be a prudent financial decision. It's a step towards achieving financial freedom faster and minimizing the overall interest burden.
Things to Consider
Prepaying your home loan can be immensely satisfying. It provides psychological relief, knowing that your debt is decreasing faster. Moreover, it can significantly reduce the tenure of your loan, allowing you to own your home outright much sooner. However, before jumping into home loan prepayment, it's crucial to check for any prepayment penalties or charges that your bank might impose. Furthermore, ensure that your primary emergency fund is well-stocked, so you don't find yourself in a tight spot later.

Suggested read: 7 Best Ways to Reduce Home Loan EMI Amount in 2023

The Potential of Equity Investment
The Basics of Equity Investment

 Equity investment involves buying shares of a company in the hope that they will increase in value over time. The stock market, with its potential for high returns, can be a tempting place to park your festive bonus.
Historically, equity investments have offered higher returns compared to other asset classes, especially over the long term. This can be particularly beneficial if you're looking at long-term wealth creation. Moreover, with the right research and investment strategy, equities can offer a diversified portfolio, spreading risk across sectors and industries.

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Risks and Considerations

 However, equity investments are not without risks. The stock market can be volatile, and there's always a possibility of losing a part or even all of your initial investment. It's essential to be aware of your risk tolerance, invest in well-researched stocks, and perhaps most importantly, not put all your eggs in one basket.

Comparative Example

Consider a resident of Delhi, Mr. Verma. He currently has a substantial outstanding home loan of ₹1 Crore at an interest rate of 7% with a tenure of 15 years remaining.  He receives a festive bonus of ₹5 lakhs.
If Mr. Verma decides to use the entire bonus amount to prepay his home loan, he can achieve a significant reduction in his outstanding loan amount. This not only decreases the principal amount but also substantially reduces the interest he would pay over the loan's remaining tenure. The result? A shorter loan period and substantial savings in interest payments. The psychological relief of reducing a large debt can also be a compelling reason to choose this option.
Alternatively, if Mr. Verma opts to invest the ₹5 lakhs in the equity market, assuming an average annual return of 12%, the potential for growth is considerable. Over a span of 15 years, thanks to the power of compound interest, his investment can multiply manifold. This route can lead to significant wealth creation, especially if the markets perform favorably and Mr. Verma makes informed investment decisions.
In this scenario, deciding between home loan prepay or invest is definitely a challenge.

Making the Final Call: Should I Prepay a Home Loan or Invest?

 Your decision between home loan prepayment or invest should be based on your current financial situation, future goals, and risk tolerance. If being debt-free is a priority and you have a high-interest home loan, prepayment might be the way to go. However, if you're eyeing long-term wealth creation and are comfortable with some degree of risk, investing in equity can be more lucrative. Always remember, the key is to diversify, whether it's different investment avenues or a mix of prepayment and investment.
Still unsure about what to do with your bonus? Consulting with a financial advisor can provide clarity. They can offer personalized advice tailored to your needs, ensuring that your festive bonus is put to the best possible use.

FAQs about Prepay a Home Loan or Invest in Equity

Whether to invest or pay off your home loan depends on individual financial goals, risk tolerance, and the interest rate of the home loan. If your home loan has a high interest rate, paying it off may provide guaranteed savings. However, if you can achieve higher returns from investments than your loan's interest rate, investing might be more beneficial.

Prepayment of a home loan can be a good idea if you wish to reduce your debt burden and save on interest. It can also provide peace of mind by moving you closer to owning your home outright. However, it's essential to consider any prepayment penalties and compare potential savings with potential investment returns.

The best time period for a home loan varies based on individual financial situations. A shorter tenure means higher EMIs but less total interest paid, while a longer tenure results in smaller EMIs but more interest paid over the loan's life. It's crucial to choose a tenure that aligns with your monthly budget and long-term financial goals.

The primary risk of prepayment is the potential opportunity cost. The money used for prepayment could have been invested elsewhere, possibly earning a higher return. Additionally, some banks or financial institutions may charge prepayment penalties, especially if the source of prepayment is the refinancing of the loan.

Disadvantages of principal prepayment include potential prepayment penalties, losing out on potential investment opportunities, and diminishing the tax benefits you receive from the interest paid on the home loan, especially if there are tax deductions available in your country for mortgage interest.

Rules for home loan prepayment vary by lender and the specific loan agreement. Generally, you can prepay any amount at any time. However, some lenders might charge a penalty for prepaying, especially in the early years of the loan. It's essential to read your loan agreement or consult with your lender to understand the specific rules.

Typically, there is no limit to how many times you can prepay your home loan. However, each prepayment might be subject to minimum or maximum limits set by the lender. It's always advisable to check with your lending institution for specific guidelines.

Yes, prepayment can reduce the tenure of your home loan. When you prepay, the outstanding principal amount decreases. While your EMI amount remains the same, a larger portion goes towards repaying the principal, which in turn reduces the overall tenure of the loan.

Published on 19th October 2023