Ask Money Today: I have a surplus of Rs 15 lakh. Should I invest in a mutual fund or prepay a home loan?

Question: I have a surplus amount of Rs 15 lakh. Should I invest in a mutual fund or prepay a home loan?

Yojana, Ahmedabad

Reply by Mayank Bhatnagar, Chief Operating Officer, FinEdge

The dilemma among investors of whether the priority is to be accorded to paying off an existing liability (like a Home Loan) or to invest the amount for furthering an existing goal or achieving a new one is truly a tough one.

Our view based on sound financial planning principles remains that priority needs to be given to repayment of any liability. This brings peace of mind and financial stability in any household.

The present trend of rising interest rates has caused a comparable impact on the interest rates for home loans too. Since May last year, the repo rate has risen by 250 basis points to 6.50 per cent. When interest rates on home loans increase, the EMI also increases, which can put an additional burden on households that have taken home loans. The increase in EMI can affect a household's budget and may force them to cut back on their spending in other critical areas.

For example, if one has availed a home loan with floating interest rate of 8 per cent per annum for a tenure of 20 years. The monthly EMI for such a loan of Rs 50 lakhs would be around Rs 43,391. However, if the interest rate increases to 9 per cent, the monthly EMI for the same loan amount and tenure would increase to around Rs 46,274, which is an increase of almost Rs 2,883 per month.

In addition, equity markets are undergoing a protracted consolidation phase, and the potential (non-assured) arbitrage of 1-2 per cent over the existing home loan rate just doesn’t make sense at this point.

This increase in EMI can have a significant impact on the household's budget, especially if they have other financial commitments to fulfil. They may have to cut back on their discretionary spending or reduce their savings to manage the increased EMI burden. In extreme cases, they may even have to consider refinancing their loan or selling their property if they are unable to keep up with the EMI payments.

The only exception to the above would be in case your home loan is in the last quartile of repayment. In that case, most of the interest is already paid and only principal remains – so it makes no sense to prepay at this stage.

Lastly - when making a prepayment decision, also consider the ‘non-financial’ gain of owning your property earlier! You can’t put a price tag on being ‘financially free’, but it’s always wonderful to be ‘loan free’ earlier in life so that your mental energies are freed up for other more important things.

(Views expressed by the investment expert are his/her own. E-mail us your investment queries at askmoneytoday@intoday.com. We will get your queries answered by our panel of experts.)