I have Rs 12 lakh in surplus. Should I prepay my home loan or invest for monthly income of Rs 25-30k?

I have cash surplus of Rs 12 lakh.  Should I use this amount to prepay my parents' home loan of Rs 7 lakh or should invest it? What is a wiser decision in the long term? Where and how should I invest the entire/remaining amount to generate a monthly income of at least Rs 25 - 30k per month? I'm 23 with a moderate risk appetite.

Reply by Balwant Jain, a tax and investment expert

It is not an easy question to answer as the answer would depend on various factors.

Firstly, tax impacts the decisions to repay a home loan. So in case your parents are claiming tax deduction under Section 80C for principal repayment and under Section 24(b) for interest paid, you will have to take into account the tax impact of repaying the home loan. In case the part prepayment does not impact tax deductions of your parents, you may consider repaying part of the home loan.

Secondly, before you take the decision to repay the home loan you need to take into account the future needs for funds for known reasons as well as for any emergency as the home loans are available at relatively cheaper interest rates as compared to 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.

Thirdly, while evaluating the option of prepayment of the home loan, please take into account the return potentials of the alternative investment products available for deployment of your surplus funds. In case the returns from such product are expected to be higher in the long run it does not make sense for you to prepay the home loan which is also has long tenure. One such alternative avenue available for investment is bonds of NBFCs. The other alternative, depending on your risk profile, may be investing the money in equity through equity-oriented schemes of mutual funds for a minimum of 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 10 years in most of the cases. You need to compare the post-tax rates/returns in both the cases, to arrive at comparable numbers.

Fourthly, if you have any other loan outstanding with higher rate of interest, it is no no-brainer to prepay all those loans/credits before you even think of repaying your home loan.

And lastly and most important factor which plays out in maximum number of cases of prepayment of home loans is psychological factor. People of the old school of thought do not want to have any debt on their heads and specifically on their place of residence even if financially it does not make sense for them. So the decision is yours whether you belong to the old school of thought or the new school of thought.

As far as the question of deploying your fund is concerned, your expectations of returns are too unrealistic. Expecting Rs 30,000 every month on Rs 12 lakhs work out to annual return of 30% which no asset class can give you with reasonable degree of safety. You can invest this money in equity oriented mutual fund schemes spread over the next 12 months with annualised return expectations of around 12% if invested for more than seven years.

(The views and investment tips by investment experts are their own and not that of Business Today. Readers are encouraged to consult a qualified financial advisor or a SEBI-registered investment advisor before making any investment decision)