Prepay Home Loan vs Invest: The Opportunity Cost Dilemma
You've got a bonus or saved up a surplus. Should you throw it at your home loan to reduce debt, or invest it for potentially higher returns? This is one of the most common financial dilemmas for Indian homeowners.
Real Example: Rahul has a ₹50 Lakh home loan at 8.5% with 15 years remaining. He has ₹5 Lakh surplus.
- Option A (Prepay): Reduces loan to ₹45L, saves ~₹8.5L in interest over 15 years.
- Option B (Invest): ₹5L invested at 12% grows to ₹27.4L in 15 years. After 12.5% LTCG tax on gains, he gets ~₹24.7L.
For Rahul, investing creates ₹16L more wealth than prepaying! But this assumes he stays invested for 15 years and markets deliver 12%.
How Does This Calculator Work?
The calculator compares two scenarios using your inputs:
Scenario 1: Prepay the Loan
- Reduces outstanding principal by your surplus amount
- Calculates new EMI OR new tenure (you keep same tenure, EMI reduces)
- Computes total interest saved over remaining tenure
Scenario 2: Invest the Surplus
- Invests the surplus as lumpsum in equity/mutual funds
- Compounds at your expected return rate over remaining loan tenure
- Applies LTCG tax (12.5% on gains above ₹1.25L) for post-tax value
Key Formulas Used
EMI Calculation
EMI = P × r × (1+r)^n / [(1+r)^n - 1]
- P: Principal (Loan Amount)
- r: Monthly interest rate (Annual Rate / 12 / 100)
- n: Total months (Years × 12)
Interest Saved on Prepayment
Interest Saved = (Old Total Interest) - (New Total Interest)
Where Total Interest = (EMI × Months) - Principal
Investment Future Value
FV = P × (1 + r)^n
For lumpsum investment with annual compounding.
Post-Tax Value (LTCG)
Post-Tax = Corpus - [(Gains - ₹1,25,000) × 12.5%]
Only gains above ₹1.25 Lakh are taxed at 12.5% for equity investments held over 1 year.
Factors to Consider
When Prepaying Makes Sense:
- High Loan Rate: If your loan rate is 9%+ and you're risk-averse
- Emotional Peace: You value being debt-free over maximizing returns
- Job Uncertainty: Lower EMI provides financial buffer during tough times
- Near Retirement: Don't want to carry debt into retirement years
- No Tax Benefits: You're in new regime or already exhausted 80C/24b limits
When Investing Makes Sense:
- Lower Loan Rate: Your loan rate is 7-8% and you can earn 12%+ investing
- Long Time Horizon: 10+ years for compounding to work its magic
- High Risk Tolerance: You can stomach market volatility
- Tax Benefits Active: You're claiming full 24b (₹2L) interest deduction
- Stable Income: No EMI payment concerns even in downturns
The Break-Even Analysis
To match the guaranteed return of prepayment, your investment needs to beat your loan rate after taxes:
Required Investment Return = Loan Rate / (1 - Tax Rate on Gains)
At 8.5% loan rate and 12.5% LTCG tax, you need: 8.5% / 0.875 = 9.7% investment return to break even.
Historically, equity mutual funds have delivered 12-15%, making investing often the better mathematical choice.
The Verdict: Which Should You Choose?
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Balanced Strategy:
1. First, build 6-month emergency fund
2. Max out 80C investments (PPF, ELSS) for tax savings
3. If loan rate > 9%: Prepay aggressively
4. If loan rate < 8% AND you have 10+ years: Invest in equity SIP
5. Split approach: 50% prepay + 50% invest for peace of mind
Frequently Asked Questions (FAQs)
Should I prepay my home loan or invest?
Mathematically, invest if your expected return (after tax) beats your loan rate. At 8.5% loan rate, you need ~12%+ pre-tax equity returns. But for risk-averse people, prepayment is a guaranteed 8.5% return with zero market risk. It's about your risk appetite and financial goals.
What is the opportunity cost of prepaying a loan?
Opportunity cost is the potential return lost by prepaying instead of investing. If you prepay ₹10L on an 8.5% loan, you save ~₹8.5L interest over 20 years. But that ₹10L invested at 12% becomes ₹96L - a difference of ₹87 Lakhs! However, investment returns aren't guaranteed while interest savings are.
Do I lose tax benefits if I prepay home loan?
Partially, yes. Under old regime: Principal repayment qualifies for 80C (₹1.5L), Interest qualifies for 24b (₹2L self-occupied). Prepaying reduces your loan, which means less interest in future years. If your annual interest is already below ₹2L, prepayment won't affect your 24b benefit.
Is it better to reduce tenure or EMI when prepaying?
Reduce tenure for maximum savings. Why? You pay less total interest. Reduce EMI if you need monthly cash flow relief. Example: On ₹50L loan at 8.5% for 20 years, reducing tenure saves ~15% more interest than reducing EMI for the same prepayment amount.
What is the ideal loan prepayment strategy?
A balanced approach: (1) Build 6-month emergency fund first - never prepay with your last savings. (2) Max out 80C/80CCD investments for tax savings. (3) If loan rate is high (9%+), prepay. (4) If loan rate is low (7-8%) and you have 10+ years, invest in equity SIP. (5) When in doubt, split 50-50 for psychological comfort.