Repay the loan or invest the bonus?
Many experts would recommend our priority should be to pay off high interest debt. Needless to say, paying off debt will provide you with peace of mind. It will also help you free up funds for other obligations/goals. Here’s how you can use your surplus cash smartly.
Jan 2023
4 mins read
Share:
Prepaying principal
Paying off a home loan at the earliest should be treated as a mind game and not a numbers game as several surprises— job loss, demise of the sole breadwinner, serious illness, etc.—can cause trouble during the 10–15-year loan period.
When you prepay a part of the loan, it goes towards the principal payment. The moment the principal comes down, so will the interest cost. Paying off your home loan early can save you lakhs of rupees over the loan duration. You will have the extra money to spend on other things because you are no longer making monthly home loan payments. You may, for example, utilise the additional funds to pay for your child's college tuition or to prioritize goals like retirement.
Retire high interest debt
A bonus or acquisition of sudden wealth can also be effectively used to pay off high-interest debt which can help clear finances for other expenses. The biggest advantage of paying your debts early is you stop paying the interest. Over the longer repayment tenure, you end up paying a high-interest amount. Hence, repaying the loans early would save interest. Clearing off the dues by repaying them as and when possible reduces your financial burden and gives you peace of mind.
Benefit of prepayment
When you make a prepayment on your loan, it reduces the outstanding principal amount. This is critical as the following month's interest will be computed solely on the leftover principle amount, which has two significant consequences. In the next EMI, there will be one lower interest component and two higher primary components. This can significantly cut the interest component for the remainder of the loan's tenure while also allowing the principal to be repaid more quickly. As a result of your prepayment, you will be able to close your loan considerably sooner than you anticipated.
Assume you have a loan of Rs. 20 lakh with 20-year tenure paying interest of 7.5%. Your EMI is Rs. 16,111 per month. You end up paying Rs. 38.7 lakh at the end of 20 years, with interest component of roughly Rs. 18.7 lakh on a loan of 20 lakh. If we look at this scenario, you are paying almost the same amount as principal as interest.
Scenario 1-Home Loan with Rs. 20 Lakhs
Let us look at another example. Assume you take a 25 lakh home loan with a 20-year repayment period at 8%. Your monthly mortgage payment is Rs. 20,911. Prepaying a lump sum of 5 lakh after 12 months saves more than 12 lakh in interest during the tenure of the loan. If you are nearing retirement, you could prepay your home loan to minimize liabilities and enjoy a more tranquil retirement.
Scenario 2 – Home loan Rs. 25 Lakhs
Alternatively, instead of prepaying loan, you can invest surplus cash to make up for the interest paid on your loans or create corpus for exigencies or invest for long term goals.
Create emergency fund
Bonus can be used to create an emergency fund that can help if you were to face an unexpected and costly medical issue or are unable to work for any reason. Building an emergency fund will help you prepare for life’s unforeseen exigencies.
Invest for long term goals
Investing the bonus or surplus cash can help you reap significant benefits in the years to come. Your bonus would be used to fix the investment gaps in your financial plan. Most of our savings can be used for long-term goals such as retirement, kids' education, and so on.
Investing the surplus cash can help you reach your goals faster. Bonus can be partially used to build a corpus for a down payment to purchase a house. Further, one can make his/her money work for by investing early and taking advantage of compounding benefits. Assuming you invest Rs. 5 lakh lumpsum you would accumulate Rs. 21.57 lakh in 19 years, assuming 8% CAGR. This shows that you recover your entire interest component paid to bank. However, the key aspect here is that you should be able to hold on to this investment for such a long period.
To conclude, the decision to prepay the principal or investing the same would depend on your individual goals, circumstances and financial discipline.
Share:
PGIM India Asset Management Private Limited
(CIN - U74900MH2008FTC187029)
Toll Free Number: 1800 266 7446
Email: care@pgimindia.co.in
This is an Investor Education and Awareness Initiative by PGIM India Mutual Fund.
All the Mutual Fund investors have to go through a one-time KYC (Know Your Customers) process. Investor should deal only with the Registered Mutual Funds (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit https://www.pgimindiamf.com/ieid.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. Read more
All the Mutual Fund investors have to go through a one-time KYC (Know Your Customers) process. Investor should deal only with the Registered Mutual Funds (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit https://www.pgimindiamf.com/ieid.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. Read more
The information contained herein is provided by PGIM India Asset Management Private Limited (the AMC)
on the basis of publicly available information, internally developed data and other third-party
sources believed to be reliable. However, the AMC cannot guarantee the accuracy of such information,
assure its completeness, or warrant such information will not be changed. The information contained
herein is current as of the date of issuance* (or such earlier date as referenced herein) and is
subject to change without notice. The AMC has no obligation to update any or all of such
information; nor does the AMC make any express or implied warranties or representations
as to its completeness or accuracy. There can be no assurance that any forecast made
herein will be actually realized. These materials do not take into account individual
investor's objectives, needs or circumstances or the suitability of any securities,
financial instruments or investment strategies described herein for particular investor. Hence,
each investor is advised to consult his or her own professional investment / tax advisor / consultant for advice in this regard.
The information contained herein is provided on the basis of and subject to the explanations, caveats and warnings set out elsewhere herein.
The views of the Fund Manager should not be construed as an advice and investors must make their own investment decisions regarding investment/ disinvestment in securities market and/or suitability of
the fund based on their specific investment objectives and financial positions and using such independent advisors as they believe necessary.
