Should you prepay your home loan or invest? The math, tax, and comfort factors explained

You have managed to save a bit of extra money, but now comes the tough question: Should you use it to prepay your home loan or invest it instead?

It’s a dilemma many homeowners face. On one hand, the thought of living in a debt-free home brings a deep sense of comfort. On the other hand, there’s the rational voice in your head that says, “What if this money could work harder for me elsewhere?”

Income tax benefits

The interest paid on a home loan allows you to claim deductions under the old tax regime, which can significantly reduce your annual tax liability. Therefore, before making any prepayment, you must do your thorough calculations.

The introduction of the new tax regime has generally reduced the significance of these deductions for many taxpayers. However, the benefits remain highly relevant if you opt for the old tax regime

Prepayment charges

The charging of this prepayment penalty depends heavily on the type of lender and the source of the funds used for prepayment.

However, commercial banks may still apply charges. Jain advises that some banks might permit prepayment up to a certain percentage of the outstanding balance at the start of the year penalty-free, but anything beyond that threshold could attract a fee.

Should you invest when returns outpace your loan interest?

If your investments, say through an SIP, can earn you more than what you are paying as loan interest, it might make more sense to let your money grow.

For example, investing ₹10,000 per month in an SIP earning 12% annually for 20 years can build a corpus of over ₹91,98,574. In contrast, prepaying the same amount towards your loan might only save a fraction of that in interest.

According to Balwant Jain, the fundamental decision between prepaying a home loan and investing hinges on a simple rule: compare your expected post-tax investment returns with your current post-tax home loan interest rate.

"Therefore, investors should deploy surplus funds into equity SIPs rather than prepaying, provided they evaluate and compare the post-tax rates of both options," said Jain.

Yes, the comfort of being debt-free is priceless, but the power of compounding can create a much larger sense of financial freedom in the long run.