Pay off housing loan vs investing question (equating tax benefits) - Posting here as didn't get many answers in the Discord server

[rezene]

I am not able to decide whether to pay off my housing loan or invest using the surplus every month. I have a fair idea about the benefit I will get on my investments in the long run (compared to prepaying the loan), but I want to incorporate the tax benefit (on housing loan interest and principal) into the equation. Any help would be deeply appreciated as I plan to start this strategy from Jan.

Here are the details -

• Loan interest rate - 6.7%
• Interest paid on loan so far - ~7 lakhs
• Principal paid on loan so far - 4 lakhs
• EMI - 37,000
• Remaining tenure - ~9 years
• Outstanding principal - ~26 lakhs
• Outgoing interest (if I stay the course) - ~7 lakhs

• Monthly surplus - 50,000

My original plan was to prepay 50,000 every month for the next 3 years and close the loan. This would make the total interest outgo to be roughly ~9 lakhs on the loan amount of 30 lakhs. Decent enough considering I didn't act early and have already paid ~7 lakhs to the lender as interest.

However, hypothetically, if I were to invest that same amount at roughly 8% interest rate (say, SIP on an index fund), I would get the following -

• Scenario 1 - ~2.5 lakhs as interest for 3 years (very unlikely due to the short term but this considering this tenure to compare with the scenario where I pay off the loan with the surplus)
• Scenario 2 - ~25 lakhs as interest for 9 years (compared to if I stay the course)

According to this calculator (https://usehhaf.org/loan-information/loan-calculators/mortgage-investment-analysis-calculator/), it makes sense to pay off the loan because it only considers scenario 1. It does not consider the other one.

Now comes the googly which I am unable to calculate into the mix - tax break. I am eligible for 2 lakh break on interest and 1.5 lakh on principal. My question then is - how do I add this benefit into the above calculation? What is the best strategy if my aim is to limit the loan interest outgo and use my surplus effectively?

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User oneeyedcroc on Discord suggested this: Not expert and do not have a housing loan but as per my rough calculations, if you are through 25%-30% of your loan tenure, prepayment doesnot offer that much huge benefits. In that case, you can utilize the surplus for prepayment for the next 1-2 years which would provide the most benefits. Also, after prepayments, keep the emi constant, only reduce loan tenure.

Edit: This is what I finally decided on. If all goes well, I'll update this thread or create a new one around Dec 2023.

 

[joneshomes]

@rezene Quick from top of the head calculation tells me you’re better of maximizing your prepayment only as much as can be tax deducted but if you want peace of mind than close the loan ASAP.

 

[rezene]

@joneshomes Thanks. I did calculate that and with the EMI (with no extra payments), I will end up paying 1.7 lakh as interest and 2.7 lakh as principal. Just about solid with the tax perspective.

But in another comment I made, this tax benefit sits sore when I consider interest rate rise and market risk (investing part).

 

[joneshomes]

@rezene You have already paid most of the interest on the loan if you adjust for inflation, there is not much point in my opinion to save 7 lakh over 9 years by forgiving the opportunity to earn much better in the equity market over the same 9 years. Again if you want peace of mind you pay off the principle but you can’t decrease the principle with early payments, you just lose the time in the market if you do that.

 

[rezene]

@joneshomes

7 lakh over 9 years

Things take a turn when the rate increases to 7%, 8% after a year, and 9% after that. This becomes 10 lakhs over 9 years but still negligible. Let me think.

 

[coombeezz]

@rezene life can happen.. prepay the loan as fast as possible. not sure about your case with the bank, but in some cases, rates are linked to repo rates.

 

[talkfusion]

@coombeezz what if home loan is insured and getting tax benefit?

In my case,
principal amount 21 lakh
principal paid 12 lakh
interest paid 7.5 lakh

outstanding 9 lakh
interest left around 2.5 lakh
loan end date march 2030.

as most interest part is already gone. I had done partial payments in past.
I need cash in near future for marriage.
Should i continue prepaying?

 

[sitbackandrelax2]

@rezene My thought process on this:

• Every penny that i have loaned is debt and i never want to invest with borrowed money
• Covid has taught me that life can take a u turn very quickly so having no loan is the best option for the mind and family - so prepay first

 

[mrjerseys]

@rezene I had done this calculation for myself for a loan of 26 lakhs with tenure of 15 years. What i found was that if i close the loan within first 4 years, and then continue to invest all of my emi into 10% ROI instruments, then only if benefited me. Otherwise it was better to just invest that amount as the interest portion in the loan keeps coming down with each passing year.

In later years of the loan, the effective interest is really low. These banks take up their majority of interest payment within first half of the tenure. So beyond that you are basically getting low interest money which you can invest in high interest instruments.

I am currently in my 2nd year of loan, and plan to close it in next eight months by aggressively saving, as i am paying per month 11k in interest. However as i am in 30% tax bracket, so taking tax deduction in account, i am effectively paying 7.5k interest per month. You have to look at it this way of calculating effective interest.

Nonetheless I am going to close my loan. The tax benefit of 3.5k per month is not worth it. At the end of the day, the interest paid does not remain with me. It either goes to the bank as interest, or 30% of that amount goes as extra tax after closing the loan. I prefer the latter.

Also looking at the current market, the valuation seems to be quite inflated and hence it does not seem to yield considerable returns in next few years. Hence i would close the debts with my saved capital.

 

[rezene]

@mrjerseys Makes sense. Thanks.

 

[rezene]

Found this strategy from an old thread. Decent strategy but not useful for me as 3 years have already lapsed into my loan, plus it does not make any prepayments in the first 3 years, thereby seeing maximum interest outgo.

 

[jcroce12]

@rezene I prepaid my home loan just last month.
These calculations are fine but for me the most important thing was getting rid of the debt. You never know what happens in the future and now I can invest all my EMI and the surplus amd accumulate the corpus again.

In your case since the tenure is still quite long it might not be wise to use 100% of your surplus to pay the loan, but you should try to close the loan ASAP. I know my answer isn't technical or what you were looking for, but just my two cents.

 

[ihavefaithinjesuschrist]

@rezene I was loan officer earlier so let me tell you my perspective on Housing loan if you have insured your loan then it is wise to invest the surplus in stock market (read it "index fund") in this case the intrest you'll be paying will be covered by the cost appreciation of the property you mortgaged.
But but if you haven't insured the loan then priorities prepayment asap. Cause I have seen many family members suffering in cases of unforseen events.
Don't count the term insurance as back-up it is for their future not for paying your liability.

 

[rezene]

@ihavefaithinjesuschrist What if my term insurance amount was reached at by calculating in the loan liability, which it was? I didn't insure my housing loan as mine is an apartment as opposed to a standalone house (which demands insurance more IMO).

 

[ihavefaithinjesuschrist]

@rezene First thing if you already considered loan while calculating your term plan then you should invest this amount. Cause at one side you'll be decreasing your liability in systematic way and the same time you're creating new asset by investing surplus elsewhere.
For your query regarding home insurance premium- premium is dependent on principal amount,tenure and type of property i.e. residential or commercial.
Appartment/independent house doesn't affect much the premium amount.

 

[mishbeans]

@rezene Was in a similar situation few days back [Tenure=12 years, Amount= 21 lac, IR= 7.2% closed within an year]. Yesterday, I decided to pre-pay my complete home loan amount and here are my personal views behind it:

1. Even though inflation is approx 6% and considering future value of money along with 7.2 % loan interest doesn't seem like a bad deal. But the Peace of Mind you get after closing home loan debt >>> anything.
2. Keeping home loan just for the sake of interest benefits isn't wise since over time the tax benefit become negligible (I am already in 30% bracket)
3. Even though there's 1.5 lac tax benefit from Principal and 50k from interest component, however the same 80C quota gets completed from other sources including (EPF, PPF, ELSS).
4. No additional pressure on family to close off loan in case something goes wrong plus the loan EMI can be directly invested into MF + Stocks.

Additional benefit: Since I am closing off my loan early, I can surrender my home loan insurance policy and get back approx 80-90% of the policy amount.

Edit: Home Loan pre-closure in my case was at 0% additional fee, so it made more sense.

 

[nina723]

@mishbeans

Additional benefit: Since I am closing off my loan early, I can surrender my home loan insurance policy and get back approx 80-90% of the policy amount.

Can you throw some light on this? I am 3 years into my home loan and can close early. Would I be able to get back policy amount?

 

[mishbeans]

@nina723 Ideally you should, I recently went to the PNB Metlife office and surrendered mine (hardly took 1-1.5 hr). They paid me back 60%~ of the policy amount.