Loan Prepayment vs Investing
You have ₹5 lakh extra. Do you prepay your home loan or invest in equity? The math is clear - but so is the psychology.
The rule of thumb
If your loan interest rate is higher than your expected post-tax investment return → prepay. If your expected investment return is higher → invest. For most home loans at 8-9% today, a diversified equity index fund at ~12% CAGR wins mathematically - but psychology matters.
Break-even: home loan at 8.5%
Home loan interest is effectively an 8.5% guaranteed return (tax-adjusted may be ~7.2% if you claim 24b deduction in old regime). Compare to post-tax equity returns:
| Scenario | Return on ₹5L after 5 years | Winner |
|---|---|---|
| Prepay home loan (8.5% saving) | ₹7.52L (guaranteed) | Safe choice |
| Nifty 50 index fund @ 12% CAGR | ₹8.81L (pre-tax) | Invest (if 12%) |
| Nifty 50 after LTCG tax (~11.5%) | ₹8.58L (post-tax) | Invest (slightly) |
| Equity @ 9% (bad decade) | ₹7.69L | Tie / Prepay |
| FD @ 7.0% (taxed at 30% slab) | ₹6.41L (post-tax) | Prepay wins |
Prepay the loan when…
- ✓ Your loan rate is above 9% (personal/car loan)
- ✓ You are in the new tax regime (no 24b deduction)
- ✓ You lose sleep over debt
- ✓ You have less than 5 years left on the loan
- ✓ You want lower EMI to free up cash flow
Invest instead when…
- ✓ Loan rate is under 8.5% (subsidised home loan)
- ✓ Old regime: claiming 24b deduction (reduces effective rate)
- ✓ You have no emergency fund yet - build that first
- ✓ You have 15+ years left and a long equity horizon
- ✓ Employer NPS contribution not yet maxed (80CCD-2)
Tax dimension - old regime only
Section 24(b): Deduction up to ₹2 lakh on home loan interest (self-occupied). At 30% tax slab: saves ₹60,000/year in tax → reduces effective interest rate from 8.5% to ~7.2%.
New regime: No 24b deduction → effective rate stays at 8.5%. This tilts the math more towards prepayment for new-regime taxpayers.
The practical answer for most Indians
First ensure 6 months emergency fund. Then: if loan rate > 9% → prepay aggressively. If loan rate < 8.5% and you claim 24b → invest in equity via SIP. If unsure: split 50/50. The guaranteed peace of mind from being debt-free has real value that math doesn't capture.