When buying a home, many home loan borrowers make decisions based on their current financial situation. As their careers progress and financial strength increases, their dilemma is whether to increase their home loan EMI and pay off the loan first, or invest the incremental amount in an SIP without changing their home loan payment schedule.
Why does it matter?
With home loan EMIs spread over a 20-25-year tenure, even small payments in the initial years can significantly reduce overall interest outgoings over time. A home loan EMI may look like a single consolidated payment; however, it consists of two components – outstanding principal and interest. In the initial years of repayment, the interest component of the EMI is much higher because it is calculated on the outstanding principal. This method is called the reducing balance method.
To understand this, let’s take two scenarios — in the first, Aman increases the EMI and pays off the home loan, and in the second, he doesn’t make any changes in the home loan payment schedule and invests the incremental amount in .
Scenario 1 – Increasing the home loan EMI
Let’s assume Aman borrows a home loan of ₹1 crore for 25 years at 9% interest. His monthly EMI will be ₹83,920. After 5 years, he is in a position to increase the EMI and reduce the tenure to 10 years. Here’s how much interest he will save.
| Loan amount | ₹1,00,00,000 |
| Amount to be paid back after 25 years | ₹2,51,75,891 |
| Monthly EMI | ₹83,920 |
| Amount paid in 5 years | ₹50,35,200 |
| Interest paid in 60 EMIs i.e. 5 years | ₹43,62,423 |
| Opening balance on 6th year | ₹93,27,244 |
| New EMI | ₹1,18,154 |
| Amount to be paid back in 10 years | ₹1,41,78,430 |
| Total Amount paid in 15 years after reducing tenure | ₹1,92,13630 |
| Interest amount saved | ₹59,62,261 |
Now, since Aman has prepaid the entire loan in 15 years, he decides to invest the EMI amount he would have paid in mutual funds through SIP for the next 10 years.
| SIP for remaing tenure | |
|---|---|
| SIP Amount | ₹1,18,000 |
| Average Return | 12% |
| Tenure | 10 years |
| Final corpus | ₹2.64 cr |
| Returns earned | ₹1.22 cr |
Total benefit of closing the loan early:
So, if the interest saved on the and the returns earned on the investments are combined, the total benefit comes down to ₹1.81 crore.
Scenario 2: Invests the incremental amount in mutual funds via SIP
If Aman decides to invest the additional amount, here’s how much returns he will earn:
| SIP Amount | ₹35,000 | ₹40,000 |
| Average return | 12% | 12% |
| Tenure | 20 Years | 20 Years |
| Final corpus | ₹3,21,95,007 | ₹3,67,94,294 |
| Returns earned (estimated) | ₹2,37,95,007 | ₹2,71,94,294 |
Total benefit if he completes the tenure:
Now, combining the returns earned by investing and then deducting the extra interest he will be paying to the bank, his benefit will be between ₹1.8 crore and ₹2.12 crore.
Who wins?
In our example, both options deliver almost the same savings if Aman invests the exact amount saved by not increasing the EMI. However, if he continues with the home loan and invests even a little more in SIPs, the investment route could generate nearly ₹30 lakh more in savings.
There is another factor to consider. Borrowers under the old tax regime who repay their home loan early may lose the tax benefit available on home loan interest under Section 24(b) of the . Similarly, your mutual fund gains will be subject to capital gains tax.
These calculations can vary depending on the loan amount and when the borrower starts making prepayments. Increasing the EMI earlier, say within the first five years, could make early repayment more rewarding. On the other hand, investing even a few thousand rupees more each month could tilt the balance in favour of SIPs, thanks to the power of compounding. However, increasing the EMI may strain your finances.
What experts suggest
Suresh Sadagopan, founder of Ladder7 Financial Advisories, told Livemint that investors should prioritise liquidity while using annual bonuses to make the prepayments. “In my view, borrowers should consider investing the amount instead of increasing the EMI. Ultimately, everyone needs liquidity. Home loan EMI pinches only in the initial years. Eventually, as a percentage of your income, it comes down over the years and hits a comfortable spot. If borrowers invest instead of increasing the EMI, their liquidity remains intact, and pre-payment is an option they can exercise at any time. Borrowers should consider investing the incremental amount. However, annual bonuses or performance-linked bonuses can be considered for making prepayments,” he said.