Know why you should pay your home loan before time

For most people, a debt of any sort feels like an albatross around their neck. They want to get rid of it as soon as possible. Nevertheless, not all loans are the same. They differ based on their rate of interest, tax implication and etc. Thus, some loans may be better to have and pay interest to them rather than pre-paying them. For example, a home loan can be one of them as it carries one of the lowest interest rates and hence, does not hit your pocket hard. Secondly, you get tax benefits on both your interest as well as principal repayment.

Tax benefits on a home loan

The following table gives you tax benefits under the corresponding sections of the Income Tax Act, 1961.

Income Tax Act maximum deductible amount

Capital is scared and has alternative uses and hence, before deploying it, you need to check where you can get the best returns. Let us first understand the option that an investor has. He can either prepay a home loan or invest that that will earn him a decent return. For this, we have assumed that you have a mortgage of Rs 50 lakh with an interest rate of 8.7 per cent that needs to be paid in the next 20 years.

Based on the above assumption, your EMI will be Rs 44,026.15. For the entire period, you will pay an interest of Rs 55.66 lakh, and the total outgo would be Rs 1.05 crore. It is assumed that you are being allowed to take the benefit of interest on this housing loan till the loan tenure and all the savings have been invested in a mutual fund. Hence, out of the total payment of Rs 5.28 lakh (44,026.15 x 12) every year you make, the interest component will be higher in the initial years and decline gradually. The total savings would be around Rs 10.41 lakh in 20 years in terms of tax.

It implies that if you were not availing the benefit of home loan interest, you would have been paying Rs 10.41 lakh in tax. If we assume that it is invested in an instrument yielding six per cent return and post-tax, the actual yield in your hand is five per cent, the total value of your investment would be Rs 1.54 crore. Finally, if your EMI and investment are considered as outflow, your total outflow would be Rs 1.15 crore and your investment value alone would be Rs 40 lakh or more than your total outflow.

To prepay or invest

The above analysis clearly shows that you should not be in a hurry to prepay your home loan. Instead, you should invest the extra amount in mutual funds or other such avenues that suits your risk-return profile. Therefore, you should have a holistic approach to your finances before you get aggressive on investing and writing out a cheque to buy some mutual fund schemes or prepaying part of the entire home loan.