Pay off house loan or invest?

Sandriano made a comment the other day with a question as to whether it’s better to invest in the NHAI bonds at 8.2% or pay off housing loan at 9%.

My response was that it’s probably better to pay off the housing loan if all your EMIs consist of mainly interest right now, but if that was not the case then we’ll have to look at it in more detail. He is in a stage where bulk of the EMI still consists of interest, and here’s how his loan looks like right now.

Thanks always for your inputs; always helpful in making informed decisions.
I think I got my answer. Nevertheless, here are the details. Bulk of the EMI goes towards interest.
Loan Amount: 28 Lakhs (LIC Hsg Fin)
Tenure: 20 yrs
Commencement: Dec 09
Interest: Locked for 8.9% for 3 yrs (until Nov 12) and market rate thereupon
Current Interest: 8.9%
EMIs paid till date (in months): 24

We will need to use the EMI calculator to see what the payment terms for this loan currently is and how will different payment terms affect this.

This calculator shows that the monthly installment is Rs. 25,000 – and during the term of this loan you pay Rs. 32 lakhs in interest in addition to the original 28 lakhs repayment. So, the whole repayment totals Rs. 60 lakhs over the period of 20 years.

This obviously sounds like a lot at first blush but consider the fact that Rs. 28 lakhs invested at 8.9% for 20 years compounded once a year yield Rs. 1.54 crores!

Now, Sandriano has already paid 24 installments so he has 18 years left, and the NHAI bond had a 8.3% / 15 year option so let me just assume that you will be able to get 8.3% for three more years so we can have a straight comparison.

I downloaded this excel calculator for easy reference and found that on these terms – you would have paid about Rs. 6 lakhs in EMIs for the first two years, but the principal component of that would only be Rs. 1,11,084 and your outstanding principal is still Rs. 26,88,916 (out of the original Rs. 28 lakhs).

So, in a manner of speaking – it’s as if you’re going to take a loan for 18 years at 8.9% today for Rs. 26,88,916 and you suddenly get a windfall of Rs. 1 lakh and you want to see whether it makes more sense to pay off 1 lakh from the principal of this housing loan or would it make more sense to invest this in a tax free bond at 8.3% for 18 years.

If you pay off 1 lakh from the housing loan then your new principal is Rs. 25,88,916 and your new EMI is Rs. 24,082. So, your total cash outflow for 18 years is  Rs.52,01,712 (24,082 x 12 x 18)

If you hadn’t paid off this house loan then your total cash outflow would have been Rs. 54,02,808 (25013 x 12 x 18). So, by paying off Rs. 1 lakh from the house loan, you save yourself Rs. 201,096 in lower EMIs over the course of this loan.

Now, in this case – you invested Rs. 1 lakh in the tax free bonds which earned you an interest of Rs. 1,49,400 (1,00,000 x 8.3% x 18 years) and you got the 1 lakh principal back at the end of the 18 years – so the total money you made in this investment was Rs. 2,49,400, which is Rs. 48,304 more than what you would have saved had you paid off your loan in the beginning of the time period.

So, based on this simple calculation I would say I was wrong earlier as you do get a higher cash-flow  if you invest in the tax free issue instead of paying off the loan.

The one thing I would like to add is that in this comparison is that in case of investing the money – you get a very large chunk – Rs. 1 lakh at the end of 18 years, and even if you assume an inflation rate of 6% for 18 years – that one lakh will only be worth approximately Rs. 35,000.

In contrast – the EMI savings are constant throughout the time period and by virtue of not being lumpy their value might be more in terms of present value despite the absolute number being low.

I know that you can add many more variables to this calculation like tax saved, present value of future cash flows, reinvestment of interest etc. but based on my earlier post in which I compared the tax free bonds to a SBI fixed deposit – I feel that adding so many variables right at the beginning overwhelms many people without having any commensurate benefit.

Finally, given this situation what would you do and what are the other factors that you consider while deciding whether you should pay off debt or make an investment?

68 thoughts on “Pay off house loan or invest?”

  1. Hi,
    I am into different situation. I have a loan at 4.5% interest rate and I can contribute to PPF and get better rates. Now tell me which option is better. I guess PPF is better but still want to be sure.

  2. Senior cityzen.
    A)planning to buy apartment in sr cityzen housing.cost Rs 55 lacs.
    B)pension Rs 55000pm.fixed deposits Rs 75 lacs.bulk of FD at interest of 8.9% pa.
    C)planning for Rs 25 lacs loan,at 10% interest pa.repayment Rs 30000 emi 12 years.
    Is it ok,do we need to reduce loan by FD withdrawal.
    Pl adv

  3. we are planning to purchase independent house in hosur, cost of the house is 21 lakhs. My I working at present and me and my husband salary put together is 50,000/- pm. we are planning to take 21 lakh loan and tenure of 20 to 25 yrs to which i might have to pay 20,000/- per month atleast. I might be resigning once loan is processed. I have fixed deposit of Rs.15 lakhs presently which includes my Full & final settlement. What do you suggest. My husband salary is Rs.25000/- pm. i have plot also in hosur which is valuable for 7lakhs at present.

  4. iam taking a loan of 25 lakhs and my loan has been sanctioned but at the time of technical visit of bank executive he said that this house and near house have a common slab and this is the problem by which the property cannot be sanctioned but which house i am purchasing that was built in 1998 and near by house is built in 2004 then how can i solve the problem

  5. Dear Sir,
    i am having surplus money of 2-3 lacks,
    Should i repay my Home Loan (22lacs) principal recently taken,
    or invest in FD or mutual fund for 10 years

    Pls suggst

  6. Dear Himanshu Just now left IDBI bank on the month of August as I need Rs.20 lac ros for pay the bulider to take possion I can pay the EMI of RS.25000/ PER MONTH PL ADVISE

  7. I’d keep the loan – the 30% tax benefit on 1.5 Lakhs that I get every year pushes my decision to keeping the loan. Plus, try and find a better FD that gives your north of 12% interest pa.

  8. for the new home price is 25 lac and i can earn rent wil be 8000 pm
    also the 21 is home loan & emi 30000 approx @11% flat
    so in this case what will the approx home price in coming 16 yrs & how much i required to pay

    if i save 30 thousand pm in fix interest insted of home purchase @8.5 what will be amount of money after 16 yers
    plz sugest that
    in what terms i can get benifit
    to purchase new home or saving?

  9. If you are nearing retirement and certain that you have accumulated enough savings to live on, paying off your mortgage can be a sensible choice. For many people, however, investing is a more financially realistic option as this gives some safety buffer against financial emergencies or losses.

  10. Sir, I want to take loan of 10 lakhs from lic housing finance ltd for the term of 20 years if i wish to pay it within 10 years i can…do i have to pay the interest for 20 years? please advise and suggest

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