Should You Invest Your Money or Use It for Home Loan Prepayment? Home Loan Blog - Tata Capital

Prepay your Home Loans or Invest?

Mar 09, 2017

Most people often wonder how to make the best use of their annual bonus or any unexpected receipt of a lump sum amount. They may choose to invest this money and create wealth for the future. Alternatively, the money may be used to pay outstanding debt obligations like loans.

Here are three conditions that must be assessed while making this decision

Individual perception

Some people are uncomfortable with large outstanding loans and would prefer pre-paying these amounts to reduce their stress. Generally, loans taken for buying a house have long tenures. Consider if you lose your job or a family member suffers from a severe illness, paying the installment may become difficult. In such instances, a person may prepay some portion of the outstanding amount with the additional money.

Tax benefit

For individuals who do not feel overstressed with an outstanding home loan, continuing to service the monthly installment is advisable. The Income Tax Act, 1961 provides tax benefits on these loans. The principal is considered as an investment under section 80C. Additionally, the interest on the loan amount is deducted from the taxable income under section 24. The maximum deduction (on self-occupied properties) for interest paid on the loan is capped at INR 2 lakh per annum. No deductions are available beyond this limit and borrowers must prepay the loan if the annual interest paid exceeds INR 2 lakh. There is no cap on interest deductions for non-self-occupied homes and borrowers are able to save taxes by continuing to pay the equated monthly installments (EMIs). These individuals are advised to invest the money to meet their future financial goals.

Returns on investment

Opting for investment over prepaying the loan is advisable only if the returns on investment (after tax) exceed the effective housing loan interest cost. If this is true, individuals are advised to invest in risk-free investment avenues, such as Public Provident Fund (PPF), National Pension System (NPS), and tax-free bonds. Individuals who are not risk-averse may consider investing their money in equities, which are able to deliver significant returns on investments.

Certain special loan products allow overdraft facilities to help the borrowers maintain liquidity. They may park the surplus funds in these products without considering prepayment. This option allows them to prepay the outstanding loan; however, if they need the funds in the future, they are able to withdraw this money. These products entail higher charges and knowing about this option from the institution before submitting your home loan application is recommended.