How to Decide Between Investing or Reducing Your Home Loan Burden

One of the most common financial dilemmas for homeowners is whether to use extra cash for investing or reducing their home loan burden. Both options come with potential benefits, but when you dig deeper, paying down your home loan early can lead to greater long-term financial peace and savings. In this article, we'll compare the two options using a real-life loan example, discuss tax deductions, and explain why reducing your home loan is often the smarter move.

Comparing Loan Repayment With and Without Prepayments

Let's first consider a home loan of ₹50 lakh, taken for 25 years (300 months) at an interest rate of 9%. Below is the breakdown of the monthly EMI, total interest, and total repayment without making any prepayments.

Without Prepayments

In this scenario, the total interest paid over the full tenure is ₹75,87,945, bringing the total repayment amount (principal + interest) to ₹1,25,87,945.

With Quarterly Prepayments (One Additional EMI Every Quarter)

Now, let's assume you make one additional EMI payment of ₹41,960 every quarter with your extra money. This simple step significantly reduces both the interest payable and the loan tenure.

With quarterly prepayments, the loan tenure reduces from 25 years to 12 years and 5 months. The total interest payable decreases from ₹75,87,945 to ₹33,36,120, saving you a whopping ₹42,51,825 in interest alone.

Investing the EMI Once the Loan Is Closed

Once you close the loan early, you can invest the EMI amount (₹41,960) in equity markets at an estimated annual return of 12%. Let's see how much you could potentially earn by investing the EMI for the remainder of the original 25-year period.

By investing your EMI for the remaining period (about 12 years and 7 months), you could potentially earn ₹1,50,69,903 at a 12% annual return.

How Much You Saved and Earned

By choosing to make quarterly prepayments, you not only reduce your loan burden but also set yourself up for significant gains from investments after the loan is closed.

By closing your loan early and reinvesting your EMI, your total gain (interest saved + investment returns) is ₹1,93,21,728. The combination of interest saved and investment returns far outweighs any benefits of continuing the loan for the full tenure.

Tax Benefits: The Reality of Section 80C and Section 24

Many people are misled by the idea that running a home loan for the full tenure allows them to enjoy tax benefits under Section 80C (for principal repayment) and Section 24 (for interest payments). However, the reality is often different.

Section 80C: Limited Room for Home Loan Principal Deduction

Under Section 80C, the home loan principal repayment is eligible for tax deduction, but this section has an overall limit of ₹1.5 lakh. Most people already exhaust this limit through other means like Provident Fund (PF) contributions, life insurance premiums, and tuition fees for children. Since you cannot remove these essential contributions, there's often little room left to claim the principal repayment deduction.

So, even though you're technically eligible to claim the deduction, it's highly likely that you won't be able to benefit from it.

Section 24: Interest Deduction Diminishes Over Time

Under Section 24, you can claim up to ₹2 lakh per year for interest payments on your home loan. However, in the later years of your loan, the interest component of your EMI decreases while the principal component increases. As a result, the interest deduction you can claim reduces significantly toward the end of the loan term.

Thus, the tax benefits become negligible, and continuing the loan solely for these deductions doesn't provide much financial advantage. Closing the loan early, therefore, becomes a better choice.

Advantages of Closing Home Loan Early

1. Freedom from Loan Burden Paying off your home loan early removes the financial burden from your shoulders, allowing you to live with peace of mind. You no longer have to worry about monthly EMIs and can enjoy your income without stress.
2. Flexibility with Investments Once your loan is closed, you gain more flexibility with your investments. You can adjust your Systematic Investment Plan (SIP) in case of an emergency, pause it when needed, or increase your contributions based on your goals. However, a home loan EMI is non-negotiable—you can't skip it even during tough times.
3. Significant Interest Savings Closing your loan early, especially with regular prepayments, can save you lakhs in interest payments, as demonstrated in our example. This is money that you can reinvest and grow through other means.
4. Greater Financial Security Without the obligation of home loan EMIs, you have more disposable income to build a financial safety net, invest in other assets, or save for retirement.

Leverage the Power of Small Extra Part Payments

Making small, consistent prepayments can drastically reduce the total interest you pay on your home loan. These part payments don't have to be large; even minor extra contributions can make a significant impact over time. To explore more on how small part payments can lead to substantial savings, check out our detailed article on How Small Extra Part Payments Can Save Big on Home Loan Interest.

Conclusion

While both investing and reducing your home loan have their merits, reducing your loan burden is often the wiser choice. Using a Home Loan EMI Calculator with Prepayments, you can visualize how making part payments can save you a significant amount in interest and reduce your loan tenure. Not only do you gain financial freedom sooner, but you also avoid the trap of relying too much on tax deductions that might not even benefit you fully.

Once the loan is closed, you can still invest your freed-up EMI and earn substantial returns. In the end, paying off your home loan early brings greater security, flexibility, and long-term financial peace.