Investing in mutual funds or repaying a loan, which is better?
While repaying your loan will help reduce your interest in the long run, investing can help you build wealth to take care of all those loans.
When people get surplus money such as their annual bonus, they may splurge. However, there are people who want to invest the money to build wealth while some use it to repay their loans. You need to think about whether you should repay your loan or invest the money in mutual funds. Here’s an analysis of what may be beneficial.
Repaying your loan
Before you decide to prepay your home loan, it is necessary that you assess your finances required for your financial goals such as the education needs of your children. Your financial goals are more important, especially if you need to achieve them in a couple of years. However, if you have been saving your financial goals, repaying your loan might be beneficial.
The earlier you repay your loans, the more the interest that you can save. How? Let’s say you have a loan of Rs. 14,00,000. The loan tenure is 25 months and the interest rate for the loan is 12%. Your EMI for the loan will be Rs. 63,569. The principal will be about Rs. 49,000 while Rs. 14,000 will be the interest amount.
If you have Rs. 1,00,000 with you and want to prepay the loan, you can save on the interest payment. If you prepay the loan at the end of 14 months using the Rs. 1 lakh, you will save interest of Rs. 11,092 and the loan tenure will get reduced by 1 month. Note that the earlier you prepay your loan, the more the interest you save. This is because the interest payment is higher initially as more principal amount has to be paid. So, if you prepay the loan in the above example even earlier at the end of 9 months, you will save interest of Rs. 16,700.
However, the amount saved might be less if the interest rate is less and the loan amount is low. That’s why investing the money might be more beneficial.
Another important benefit that you need to note is that home loans provide you with tax benefits. If you prepay your loans, you might have lesser tax benefits in the long run. You need to understand if the loan is giving you tax benefits and the amount of taxes you are saving before you prepay the loan so that your savings are more. If you have other investments for your tax savings, you can consider prepaying your loan.
Investing in mutual funds
If you invest Rs. 1,00,000 in mutual funds and you are getting a return of 11%, you will get Rs. 2,83,942. This is if you remain invested for 10 years. If the returns from mutual funds is much higher at 14.5%, then you will get Rs. 3,87,307 after 10 years. Investing in equity mutual funds will get you more returns than investing in debt funds. You can use the amount that you have invested to repay your loan.
This will work out really well if the return from your mutual fund investment is much higher than your loan interest rate. For instance, if your loan interest rate is 9% and you can get 14% from your investment, you can actually invest the money and use the savings to repay the loan in the long run.
Note that if you don’t have any investments to meet your financial goals, you should invest the money even if you have loans running. However, if you have many loans, it is good to repay some of them and then start investing for your financial goals.
Prepaying the loan and investing the money
If you have a good amount of money, you can consider prepaying your loan and then investing the rest of the money. For instance, if you have Rs. 4,00,000, you can use more money to prepay your loan. This way you can save on the monthly loan instalments and also build wealth in the long run. If the loan amount is higher and the interest rate is more, you can consider paying more for the loan. However, if you are getting tax benefits for the loan or if the loan amount is low, you can invest more money in mutual funds rather than prepaying more of the loan.
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