Investing in mutual funds versus prepaying your home loan is a decision that hinges on various factors, primarily your financial goals, risk tolerance, and rate of returns and interest rates. Deciding between investing in mutual funds or prepaying your home loan depends on several circumstances.
Here’s a tailored scenario for one to understand mutual funds investments vs home loan payments:
When you invest in mutual funds, you get the following benefits.
Potentially higher returns: Equity mutual funds have historically offered returns higher than home loan interest rates. This potential for higher returns can significantly bolster your wealth over the long term.
Wealth growth: By investing in mutual funds, you build a corpus for future goals such as retirement or your child’s education. Moreover, at some point in time, you would be able to repay your home loan and save the surplus amount. This is because it allows your money to potentially grow faster than the interest saved by prepaying your home loan.
Tax benefits: While prepaying your home loan might offer tax deductions on interest repayment, investing in mutual funds could provide tax benefits like long-term capital gains tax if held for more than a year.
Sanjiv Bajaj, Jt. Chairman and MD, BajajCapital Ltd., explains why investing in mutual funds is better than prepaying your home loan.
For instance, the home loan interest rate is 8.30%, and the expected mutual fund return is 12% (after considering taxes). In this hypothetical scenario, prepaying the home loan might not be optimal; here’s why
Prepayment benefit: By prepaying the home loan, you would effectively earn a guaranteed return of 8% (the interest saved).
Mutual fund potential: However, investing in mutual funds can earn a higher return of 12%, even after considering taxes. Bajaj says this presents an opportunity for greater wealth accumulation compared to the guaranteed return from prepaying the home loan.
Thus, in theory, investing in mutual funds might generate higher returns than utilising the money to pay home loans. But, Harsh Gahlaut, CEO and Co-founder of FinEdge, says, “Practically, it would make more sense to channel the money towards repaying the home loan simply because, from a personal finance viewpoint, it will lead to lower debt, which in turn should free up a higher monthly surplus to invest in a disciplined way in the future and more importantly give you peace of mind of not having a large debt servicing liability in your life.”
Nevertheless, one should do proper financial planning. While investing, one should be better off setting aside monthly surpluses towards long-term financial goals (through systematic investment plans) and channelling any ad hoc income surplus (like bonuses, proceeds from the sale of assets, etc.) towards reducing their debts.
“The key to making the right decision is to engage with an investment expert to understand your income, debt and surplus ratios and identify and map key financial goals. This will enable you to make wise investment decisions,” added Gahlaut.