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BASL Registration Number: 1951 | Non-Individual RIA. Regn No. INA000017620 | Validity Perpetual

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The Common Dilemma – Should you repay home loan or invest the surplus?

Updated: Mar 18

As per a Bloomberg report, nearly 56 per cent of individuals have availed the moratorium facility proposed by the RBI in March 2020. Anyone having a loan with banks and NBFCs could avail this benefit and did not have to make any repayments for the moratorium period. The benefit is extended till August 2020. The objective is to provide relief to those borrowers who could be facing a liquidity crunch due to the lockdown impact on jobs and business income. While this may provide temporary relief, borrowers availing this facility eventually will end up paying more loan interest.

In the period of uncertainty like the present Covid times when income is affected, an EMI can prove to be a huge burden on cash flows. Home loan is usually one of the biggest liabilities an individual undertakes in his working life. In good times though, most borrowers do not have an action plan to prepay their home loan. Many continue their home loans for a major portion of their working lives. Some even have the ridiculous reason of continuing home loan to avail tax benefits.

And then there are many who despite having a decent lumpsum on hand do not choose to prepay the loan. Instead, they look for arbitrage opportunities – comparing deposit rates and the home loan interest rates. If the returns on a fixed deposit post tax is more than the cost of loan, the surplus money is parked in fixed deposits. This investment decision is short term vis-à-vis the tenure of a home loan which spans 15-20 years or even more.

There are also people who create a plan to invest the surplus in mutual funds, wait for 5 years and then intend to repay the loan with gains. This is suicide as the returns are market linked. What people do not realise that banks recover huge interest – about 70-80 per cent of the loan amount in the initial 8-10 years of the loan tenure. Of the EMI component, a minimum 80 per cent is the interest cost and the balance part principal. Prepayment of home loan is thus advisable in the initial years of the tenure as interest outgo is higher.

Borrowing a loan and the decision to repay it is not just about numbers. It is also about the human psyche. Do you want the debt burden hanging over your head for a long time at the cost of chasing short term returns? Turning debt free is about peace of mind. It is about financial preparedness when life throws those harsh bouncers at you. The home loan tenure period of about 15-20 years is a long time and life is unpredictable. When the going is good, you may find it easy to service the loan. But any unfortunate happening – serious illness, death, loss of job, etc., may throw your finances out of gear and suddenly the loan amount may feel like a huge burden on your head. Many people have learnt this lesson the hard way in this pandemic time.

Remember, repaying home loan early on, is a significant life decision you make. So, convert your biggest liability into asset. How early you close your loan determines your financial future. Once you turn debt free, you can easily focus on funding your essential goals like planning for your retirement, child education, etc. Not just that, you will feel a lot confident and in control of your financial future, a little bolder to dream about your aspirations which you had not thought of earlier!

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