Pay off debt or Invest for Retirement?
It was in the year 200x that you took a Rs. 40,00,000 housing loan. Now 5 years later you are very comfortable with the Rs. 40,000 per month EMI that you are paying. You and your wife find that you can easily increase the EMI to Rs. 50,000 without a sweat.
Should you increase the EMI and repay the loan faster OR should you do a SIP for Rs. 10,000.
Well most people are tired of my ‘advisory’ posts, so let me NOT tell you what to do. Instead look at the pros and cons of both the options, and take a decision yourself!
Option of Repaying the Loan:
1. Most of the Indian middle class considers the loan as a burden, so prefers to repay quickly. If you are one of those persons, obviously you will repay the loan. However what you should be seeing is ‘Is the Rs. 10,000 giving me a better yield in the investment or am I better off repaying the debt – THUS INCREASING MY NET WORTH.
2. If your CTC is Rs. 20,00,000 and your wife is earning say Rs. 10,00,000 – the loan amount outstanding is very very small. It is just 15 months income. DO NOT LET THE ABSOLUTE AMOUNT WORRY YOU. Translate to ‘how many years income’. Upto 5 years is fine.
3. If you are planning to buy a bigger house in say 5 years, DO NOT REPAY THE LOAN and then take a big loan again. Instead keep a part of this loan pending and GO TO THE SAME LENDER. You can expect a waiver of processing fees, and get such other concessions.
4. Your house will appreciate / depreciate – the repayment has nothing to do with that process.
5. You will save on interest expenses, no doubt about that. However if your loan is at about 10%, remember inflation is also at about 9%. So interest rates in India are at historical lows.
6. You may sleep easier – that depends on your personality – like point 1. So you and your spouse have to take this emotional call.
What happens if you Invest for Retirement?
1. Say you put this money in an ELSS, it means you are building an all equity portfolio for the next 15 years. Nice time frame to build a nice equity portfolio. Equities, historically, over 15 year terms should give you about 2-3% REAL RETURNS.
2. Power of compounding over the next 15 years even with just a small 1-2% difference can work out to a nice return.
3. From the tax point of view both are the same. The interest payment as a tax deduction is a lousy reason to keep the loan, however, your CA tells you!!
What would I have done?
Invest in ELSS if I needed a tax break or invested in a nice equity well managed fund.
What should you do?
Read this, discuss, and learn to take a decision. Afterall it is emotional. For those of you who think it is mathematical, or logical, there is always Prof. Pattu!
http://freefincal.com/pay-off-home-loan-or-invest-for-retirement-calculator/
or you can consult famous world class financial planners who may have a different idea, for a fee, of course.
koguty
Related to personality [point #1 and #3 of repayment] –
10-11% rate of interest, 20 year loan tenure ==> you will be repaying only about 1/4th of your principal in first 10 years — so it makes sense to prepay in small chunks in the INITIAL phase of the loan.
To paraphrase Subra, emi is negative compounding — so to counter it, start (pre-paying) as early as possible. It does not make much sense to pre-pay in lumpsum or small amounts after half of the tenure is over.
Ashal Jauhari
Dear Koguty, @ 11+% retail inflation, running a loan is far far better than repaying it. 🙂 You are looking at the loan in gross numbers and not in absolute numbers or should I say purchasing value of your EMI over the years.
Thanks
Ashal
JohnD
Pl enlist me in your regular emails
Tks
John
LuckyOye
@Ashal, very precise observation! Already the EMI has reduced from a big bite of your monthly take home to a small pinch. Over the next few years, in real terms, it will become a mere scratch, even though in nominal terms, it remains the same.
Although, as subra said, if you *do* go for another home and don’t sell the old home, your EMI for the new home will become the next big bite!
Sambaran Mitra
3 more pro of paying off a loan (actually derivatives of same point — SIMPLICITY):
1. Freedom from tracking one extra online account.
2. Freedom from understanding/creating one more excelsheet.
3. Less complexity in life.
I closed my home-loan primarily to get rid of
1. one line-item in my tracking excelsheet
2. having to remember and follow-up one extra service-provider.
I did not chose home-saver/smart-home option (where you keep some money with the home-loan-bank to reduce tenure/EMI) because I could not understand it.
Hari
“Compound interest is the eighth wonder of the world. He who
understands it, earns it … he who doesn’t … pays it.”
― Albert Einstein
ishika
First look at the interest rates of your debt and your probable investment. Calculate whether the money you are investing will give you enough high returns than what you will spend on the interest and fees of the debt you are supposed to be paying off. Go only for the investment if it is getting much more returns than what you need to pay off your debt (with interest) in the future. If not, it will be a loss to you- you can rather than pay off the debt.
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