I have received some money as inheritance from my uncle. Should I invest the money in various financial instruments or rather use it to prepay my home loan to make my home loan free?
This is a very common dilemma faced by a lot of users today as home loan is a long term loan and people are better off closing the loan early to bring down the cost of ownership of the property. On the downside however, home loans offer a tax advantage for repayment of both principal amount as well as interest paid. If you prepay the home loan the tax benefits would not be available anymore.
In such a scenario you may end up with no option but to pay higher income tax. There is no one answer for your question as it depends on the outstanding amount and the money available at hand. For example in case the money you have can earn a higher interest if invested in some financial instrument than what you are paying as interest towards home loan, then investing the money is preferable. A better option would be to partially prepay the home loan keeping the EMI steady and reducing the tenure so that your final cost of ownership gets reduced substantially.
There are two cases where prepaying your loan would make sense:
You have a floating rate of interest on your Home Loan and interest rates are rising.
You got the loan recently (between one and three years ago) and the interest component is high.
There are two cases where investing in Mutual Funds would make sense:
You are getting tax benefits on your Home Loan and prepaying might reduce these benefits.
Cost of the loan minus tax benefits would be much lower than the returns you will get from Mutual Funds.
Let’s consider an example to understand this better. Suppose you have a Rs. 30 lakh Home Loan with an interest rate of 11% p.a. and a loan tenure of 15 years. If you prepay Rs. 2 lakh at the end of 3 years (after taking the loan), you would save Rs.4.81 lakh of interest on your loan. If the same was invested in a Mutual Fund earning a return of 10% p.a. for 10 years (assuming you don’t reinvest the return earned), you would get Rs. 4 lakh. So, in this case, prepaying your Home Loan is more beneficial than investing in a Mutual Fund.
If you are looking to invest in a Mutual Fund, click here.