When a lender sanctions you on a home loan, your eligibility is decided based on your income at the time of sanctions. A home loan is generally taken during the initial stage of one’s career, whereas the income increases over the years; therefore, the borrower is able to accumulate a significant amount of funds during this period.  In such a situation, every home loan borrower faces the dilemma of whether to prepay the home loan with the accumulated surplus funds or invest these funds somewhere.

It is not an easy question to answer for anyone as the answer varies from case to case and and depends on various factors. Let me attempt to explain some of the important factors that you should consider before you make the decision either way.

Tax considerations

Tax impact significantly impacts all the investment decisions, including taking out and repaying the home loan. The principal repayment of home loans is eligible for deduction under Section 80C up to ₹1.50 lakh, along with other eligible items. You are also entitled to claim a deduction under Section 24(b) for the interest paid on home loan. The amount of deduction for interest varies depending on whether the property is self-occupied or let out. Both these tax benefits are available only if you opt for the old tax regime.

If you opt for the new tax regime, no deduction is available for repayment of home loan or interest on money borrowed for self-occupied house property. Under the new tax regime the deduction for interest in respect of a let-out property is restricted to the taxable amount of rent received.

So, in case any part of the prepayment does not impact your tax deduction, you may consider repaying part of the home loan if you wish, after taking into account other factors.

Money needed in the near future

While repaying your home loan, it is very important for you to consider the immediate need for funds for known reasons and any emergency. Your decision on whether to prepay and how much to prepay should be based on both considerations. This is specifically important, considering that home loans, are generally cheaper than other loans specifically personal loans. Once you have repaid the home loan and need money later on, you may have to borrow at a higher rate of interest. So please evaluate the cash flow position for the near future before deciding  to prepay the home loan.

Returns expected from alternative investment avenues available:

This is the tiebreaker consideration for this decision. So whether to prepay the home loan or not would also depend on the return potential of the alternative investment products available for the deployment of your surplus funds and with which you are comfortable. In case the returns from such alternative investment products are expected to be higher in the long run, it does not make sense for you to prepay the home loan. One such alternative avenue available for investment is bonds being issued by NBFCs. The other alternative, depending on your risk profile, may be investing the money in equity through equity mutual funds for minimum 7-10 years as the returns on equity funds have been generally higher than home loan rates for such long tenure. This makes sense as the home loan tenures are generally longer than ten years in most cases. You need to compare the post-tax rates/returns in both cases to arrive at the decision.

Any existing loan or credit outstanding

If you have any existing loan outstanding where the applicable rate of interest is higher, you should pay that loan first before considering prepaying the home loan.

Psychological reasons

This is not only a non-monetary factor but also the most important one. People of the old school of thought do not want to have any debt on their heads, specifically on their place of residence, even if the decision does not make sense for them financially. Believe me, this psychological reason contributes to a significant number of home loan prepayment cases in India based on my interaction with many home loan borrowers. So decision is yours whether you belong of old school of thoughts or new school of thought.

From the above discussion, it becomes clear that you need to consider various factors while arriving at the right choice about prepaying of your home loan.

Balwant Jain is a tax and investment expert and can be reached on jainbalwant@gmail.com and @jainbalwant on his twitter handle.

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