Should I Prepay Home loan or start SIP in Mutual Funds?
These days many people prefer to take a home loan and purchase their dream home in young age itself. As they move along in their career or business, they might have surplus money. One thing that comes to their mind, is prepayment of home loan good or whether they should start SIP in mutual funds. If you search for related advice, everyone would give their own view and recommendations. Such decision is not plain simple. This would depend on a few factors. Should you start SIP in mutual funds or do a prepayment for a home loan?
Why this question?
When you start earning, your income could be lower. You would have taken home loan and purchased your dream home. You make progress in your professional life. You would see the following
1) Growth in your salary or business income
2) Expenses getting stabilized except for planning child education costs which can increase year on year.
3) You would have covered basic financial planning that includes life insurance, health insurance etc.,
4) You are seeing fast growth in your professional career and getting employee stock options, bonus, higher variable pay etc.,
Now you have surplus money. You are thinking whether to prepay the home loan or invest this money through SIP in mutual funds. This is where you would have stuck and thinking what is the right approach for you.
Should you start SIP in mutual or prepay home loan?
Is prepayment of home loan good? There is no plain, simple answer for this. Your decision would depend on few factors indicated:
1) Cover your basic financial planning first
Check whether you have covered your basic financial planning. Basic financial planning includes life insurance, health insurance, emergency money etc., which can dent your financials in case something unexpected thing happens. No point in thinking to prepay home loan or start SIP when these basics are not covered.
2) Do you need money in near future?
This also plays a vital role. If you need money in the near future, why do you think of prepayment of home loan? Based on when you need money, you can do simple RD or SIP in short term mutual fund to cover the short term financial goals.
3) Returns from SIP mutual funds Vs Interest payout in home loan
These days home loans are offered at 6.7% interest rate onwards. Some banks or financial institution offer at higher rate due to low CIBIL score. On the other hand, SIP in mutual funds can generate 12% annualized returns though not guaranteed. Unless there is a significant difference between the home loan interest rate Vs SIP, no point in thinking to start a SIP in mutual funds. One of my friends has home loan from LIC Housing Finance and due to low CIBIL score, he is being charged at 12% interest rate. Can he pay 12% home loan interest and expect 12% returns from SIPs (though not guaranteed)? So check the difference on loan repayment vs investment calculations before proceeding on this.
4) Want to be Debt Free
Many financial advisors keep advising their customers to get debt free sooner. Many of us even think of getting debt free sooner or later. If your motto is to get debt free sooner, with no significant difference between what you pay vs what you get, the better to do pre-payment of a home loan as and when you find some surplus money.
5) Is tax benefit is your sole purpose?
Some argue saying they would lose tax benefits by paying off the home loans. This is true. If you have a home loan for 20 years as an example and you keep paying surplus money every now and then. This 20 years might get reduced to 15 years or 10 years or 5 years. Post this, you cannot claim income tax benefit of home loan interest payment up to Rs 2 Lakhs u/s 24 and home loan principal repayment up to Rs 1.5 Lakhs u/s 80c. If your sole purpose is tax benefits, you can continue home loan and start SIP in long term mutual funds.
6) Sticking to invest
Many people take the decision of investing in Good Mutual funds through SIP instead of prepayment of home loan. However, instead of sticking to this decision, they spend surplus money on luxuries or lifestyle expenses. The whole purpose is lost. If you cannot stick to your decision about investing in mutual funds, better go for prepayment of home loan.
7) Low to moderate risk appetite, go for prepayment of home loan
If your risk appetite is moderate to low, then, I would recommend you to to prepay home loans instead of investing in SIP. With your risk appetite you can expect 7% to 9% returns or little higher. However, the home loan interest payout could be higher.
8) Home loan prepayment or increase in EMI
Instead of investing in SIP, one might also think among home loan prepayment and increase in EMI, which could be better. Again EMI increase can reduce the home loan tenure and faster prepayment of home loan. This is a good option except that again tax benefits would be lost (if your sole objective is a tax benefit).
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