Q: I have a housing loan of ₹1Crore with an interest rate of 8.5% per annum. My current EMI is ₹86,000 for a tenure of 20 years. I have an extra ₹15,000 every month that I can either use to increase my EMI and pay off the loan faster or invest in mutual funds. Which option would be more beneficial in the long run?
-Rajesh, Senior Software Engineer
A: That’s a great question, Rajesh! You’re essentially weighing the option of reducing your debt burden faster versus taking a more investment-oriented approach to potentially grow your wealth. Let’s break it down step-by-step, so you can make an informed decision.
Option 1: Pay Extra EMI to Reduce Loan Tenure
If you decide to increase your EMI by ₹15,000, it will help reduce your loan tenure and save you a considerable amount of interest in the long run. Here's how it works:
Current Loan Details:
Loan Amount: ₹1 Crore
Interest Rate: 8.5% per annum
Loan Tenure: 20 years (240 months)
New EMI: ₹1,01,000(Increased by ₹15,000)
Your loan tenure will reduce to around 14 years instead of 20 years.
By shortening the tenure, you’ll save a significant amount on the interest you’d otherwise have paid over 20 years.
Here’s the math:
Interest Paid Over 20 Years: ₹1.08 Crore
Interest Paid Over 15 Years: ₹72.91Lakhs
Interest Savings: Approximately ₹35.09 Lakhs
So, by increasing your EMI, you could save ₹35.09 Lakhs in interest and pay off the loan around 5 years earlier than originally planned.
Option 2: Invest the ₹15,000 in Equity Mutual Funds (SIP)
Now, if you decide to invest that ₹15,000 monthly in equity mutual funds instead of paying extra towards the loan, the potential returns can be quite attractive, especially if you invest for the long term. Let’s assume you’re investing in a equity mutual fund with an expected average return of 12%
Here’s what that would look like:
Monthly SIP: ₹15,000
Assumed Return: 12%
Investment Period: 14 years (since that’s how long it would take to repay the loan if you increase your EMI)
Your monthly investment of ₹15,000 at expected return12% return could grow to approximately ₹62 Lakhs in 14 years.
Which Option Makes More Sense for You?
Now, let’s compare both options:
Paying Extra EMI: By increasing your EMI to ₹1,01,000 you would save ₹35.09 Lakhs in interest and finish paying off your loan 6 years earlier. This option offers the benefit of becoming debt-free faster and saving on interest payments, giving you more financial freedom.
Investing in Mutual Funds: If you invest ₹15,000 per month in equity mutual funds, your corpus could grow to ₹62 Lakhs over the next 14 years. This offers a higher return potential, as equity mutual funds can yield strong returns over time, and the power of compounding works in your favor when invested for the long term. Historically, many equity mutual fund categories have delivered returns of around 12%, making this a realistic target. However, it’s important to remember that mutual funds come with market risks, and there's no guarantee of returns.
What’s the Best Option for You?
If your priority is to become debt-free and save on interest, increasing your EMI is a solid choice. It’s a low-risk strategy that ensures you’re free from debt sooner, with significant interest savings.
If you're willing to take on some risk and have the time to let your money grow, investing in equity mutual funds might be a better option for building a larger corpus.
A Balanced Approach: Hybrid Strategy
If you’re unsure whether to pay off your loan faster or invest in mutual funds, you could consider a hybrid strategy. Let’s take a closer look at how you could split the extra ₹5,000 to strike a balance between reducing your debt and growing your wealth.
Here’s what it might look like:
Part 1 – Increase EMI to Reduce Loan Tenure:
You could choose to use ₹7,500 from the extra ₹15,000 towards increasing your EMI.
This would bring your new EMI to ₹93,500 (up from ₹86,000).
By paying extra towards your loan, you’re reducing your loan tenure and saving on interest, just like in the first scenario.
The result: You would pay off your loan faster (in about 17 years instead of 20 years) and save ₹20.29 Lakhs in interest.
Part 2 – Invest in Mutual Funds (SIP):
The remaining ₹7,500 can be invested in equity mutual funds through a Systematic Investment Plan (SIP).
Assuming an average annual return of 12%, this ₹7,500 SIP could grow to approximately ₹31 Lakhs over the 17-year period (considering the reduced loan tenure).
Final Thoughts
If debt doesn’t bother you much, my recommendation would be to focus on building wealth rather than paying off your housing loan quickly. By investing in equity mutual funds, you’re giving your money a chance to grow and potentially earn higher returns over the long term compared to the savings from reducing your loan interest. At the end of your loan period, this approach can leave you with both a fully owned home and a strong financial corpus. While equity mutual funds carry some market risks, they also offer the potential for better returns than what you’d save by repaying the loan faster. So, if you’re comfortable carrying the loan and it doesn’t weigh heavily on your peace of mind, my advice is to invest the additional funds to grow your wealth. This way, you can strengthen your financial position both through property ownership and accumulated investments. 😊
Regards
Vishal Muralidharan.,CFP®
Mutual Fund Research Analyst
GSM Investment Services – ARN 174939
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