As an adult, most of us dream of owning a home of our own where one can start a family or retire peacefully. Purchasing or building a home is a huge undertaking as it involves a lot of investment. In order to purchase a dream home, many rely on low-interest rate home loans from the banks or housing finance companies.
Conventional wisdom suggests prepaying the loan to reduce debt as well as the interest outlay over the years, which forms a significant portion of the payment. Others suggest investing any surplus funds in equity mutual funds. Yet others might do nothing about it at all.
A simple way of looking at it is to crunch the numbers and decide on an absolute basis comparing savings to the excess (potential) returns. However, a number of other factors should also be considered, some of which are:
How comfortable you are with debt – Are you comfortable paying EMIs instead of larger lump-sum payments? Do you aim to be debt-freeas quickly as possible? What portion of your income is the EMI (i.e., where are you in your career and loan life cycle)?
The source of repayment – Is it a sale of another property? Profits from an investment? A bonus or a hike in salary? The frequency of the increased cash flow will determine how you structure your decision
Personal views on investment opportunities and interest rates – While even economists fail at predicting market returns and interest rates with alarming regularity, your personal views on the direction in which loan interest rates will move and the potential returns can upend the calculations in an instant
Thoughts on Emergency fund – Prepaying without having an emergency fund or dipping into it is a complete no-no!
Tax Repaying – There’s no avoiding death and taxes. Most calculations either ignore or overlook the impact of taxation. Your home loan contributes to tax savings and your investments have future tax implications
Liquidity – Investing in public markets leaves you room for liquidity at fairly short notice, especially necessary if you have any significant expenses coming up, something not available if you choose to prepay your loan.
Besides these factors, your personal situation also plays an important factor in this decision. Prepayment of a home loan or investing any surplus funds available in other instruments should be viewed as a personal finance tool rather than a standalone decision keeping in mind your holistic financial portfolio. When you are repaying a home loan, care must be exercised with your personal finances. Financial planning, budgeting, and regular saving should be a monthly affair for you so that you never default on a home loan.