Should you prepay your Home loan?

 

Should you prepay your Home loan?

The best part of any loan is the outgo of amount is fixed and predetermined which is called EMI. EMI remains same during entire loan term, as your salary increases the EMI remains the same, over the course of time your savings will also increase.

With the extra savings one can either prepay his loan to clear the loan faster or invest the extra funds in return earning avenues or the same funds can be invested in the form of SIP’s in Mutual Funds.

You should consider the following things before you think about prepaying your home loan:

1. Do you have a Rainy Day Fund?

Life is full of uncertainties, you would face many worst case scenarios in your life which you wouldn’t have thought or planned for like Job loss, Medical Emergency etc.

It is always advisable to stash some money say 8 to 9 months of your living expenses including your Loan obligations (EMI’s) in liquid funds or savings accounts.

2. Short term Goals

Once you set up an emergency fund your next goal should be to set up a fund for your short term goals, say 2–3 years, discuss with your family members about these goals and set up a fund for your short term goals.

3. Invest / Save / Prepay

Now you have an emergency Fund and a separate fund for your short term goals, it’s time for giving a thought for investing or prepaying your loan. Generally, rate of interest for any home loan in India would be in the range of 8 to 10% and historically it has been seen that Equity funds have given post tax returns of 12–15% (Considering the current melt down in Stock markets due to Covid-19) you can invest the surplus in Equity Mutual Funds provided you have the risk tolerance for dealing with the ups and downs of the stock market. This should be done only if you are planning to stay invested for more than 7–10 years because equity investments can be expected to give good returns over the long term only. However, if you have a low risk tolerance, then it is better to use the surplus to pay off your home loan faster

Point of interest, investing only makes sense if all or majority of it can be invested in equity mutual funds which mean you will lose a substantial amount of money in case of a market crash if and when it happens eg: Coronavirus, 2008 crash, the stock market crashed by 30–50%.

If you can sail through during these tough times without panicking then you can invest the surplus savings in Mutual Funds.

If no, pay off your loans after creating an Emergency Fund and investing for your short term goals.