Should you prepay the home loan or invest the money? Compares interest saved against after-tax investment gains, and gives the return investing must beat.
Why is the break-even return higher than my loan rate?
Because the interest you save is untaxed and the gains you make are not. On an 8.5% loan with 12.5% tax on gains, investing has to earn about 8.4% before tax just to draw level - and the higher your tax on gains, the higher that bar climbs.
Does the home loan tax deduction change the answer?
Yes, and it lowers the bar for investing. If you claim the interest under section 24(b), prepaying also destroys part of that deduction, so it saves you less than the headline figure. Enter the share you actually claim and the break-even return drops - in the example above, from 8.4% to 6.9%.
What return should I assume?
Be conservative. Long-run Indian equity has done 11% to 13% over 15 years or more, but a five year window can easily be negative. If the loan has under seven years left, the market has little time to recover from a bad stretch, and prepaying looks much better.
What if it is a personal loan rather than a home loan?
Prepay it, almost always. A 14% personal loan needs the market to return over 14% after tax just to break even, which is not a bet worth taking. The higher the loan rate, the more obviously prepaying wins.
Is there a reason to prepay even when investing wins on paper?
Certainty. Prepaying returns exactly the loan rate with no chance of doing worse, and a smaller EMI is a smaller monthly obligation if your income stops. Many people accept a lower expected return for the sleep.
Should I do this before building an emergency fund?
No. Both options lock money away. A prepayment cannot be pulled back out when the car breaks or a job ends, and selling investments in a bad month crystallises the loss. Hold six months of expenses in something liquid first.
Can I split the money between both?
Yes, and plenty of people do. Run this twice with half the amount each time to see what the split costs you against going all in on the winner. The gap is usually smaller than the peace of mind is worth.